Friday, February 25, 2005

It IS fiddling

Warning: this is a posting about accountancy. The faint hearted may wish to move on.

I posted here about the UK government's change to the way they treat road repairs in the national accounts, and the concern that this was driven by a need to meet Gordon Brown's golden rule.

I've done a bit of gentle digging since then and here are the results of that work.

I contacted the Office of National Statistics to ask about the rules that are in force in this area and was pointed to the UN system of National Accounts. The link is here.

There I found this (all emphasis is mine):

Maintenance and repairs

The distinction between maintenance and repairs and gross fixed capital formation is not clear-cut. The ordinary, regular maintenance and repair of a fixed asset used in production constitutes intermediate consumption. Ordinary maintenance and repair, including the replacement of defective parts, are typical ancillary activities but such services may also be provided by a separate establishment within the same enterprise or purchased from other enterprises.
The practical problem is to distinguish ordinary maintenance and repairs from major renovations, reconstructions or enlargements which go considerably beyond what is required simply to keep the fixed assets in good working order. Major renovations, reconstructions, or enlargements of existing fixed assets may enhance their efficiency or capacity or prolong their expected working lives. They must be treated as gross fixed capital formation as they add to the stock of fixed assets in existence.
Ordinary maintenance and repairs are distinguished by two features:

(a) They are activities that owners or users of fixed assets are obliged to undertake periodically in order to be able to utilize such assets over their expected service lives. They are current costs that cannot be avoided if the fixed assets are to continue to be used. The owner or user cannot afford to neglect maintenance and repairs as the expected service life may be drastically shortened otherwise;

(b) Maintenance and repairs do not change the fixed asset or its performance, but simply maintain it in good working order or restore it to its previous condition in the event of a breakdown. Defective parts are replaced by new parts of the same kind without changing the basic nature of the fixed asset.

In essence this is identical to a standard UK company accounting treatment: if you are just putting the asset back to it original state then you are repairing it and you cannot put the cost on the balance sheet.

Except that's what the government appears to be trying to do. They are going to have to string together quite an argument to explain why they think this is acceptable under the rules. It's certainly hard to imagine anything they could say which would pass muster with a commercial auditor.

Perhaps these are guidelines rather than rules? I went back to the ONS to find out about the UN system and whether it binds the UK government. The answer came back a few hours later:
[T]he situation is that as an EU member state, the UK is obliged in its National Accounts to follow the European System of Accounts 1995. This is consistent with the earlier (1993) UN System of National Accounts [...]

With the evidence I have, it looks to me as if the government is flouting the regulations it has signed up to, in order to meet its self-imposed golden rule. This matters because of the effect it might have on the financial markets- it will surely dent the Chancellor's reputation for prudence. (When was the last time you heard him mention dear old Prudence?) I can only assume that the markets will apply a risk premium to UK debt if they think the accounts can't be trusted, and that will cost us all money in the end.

The ONS have stated that the change was part of their regular review of policies and was not due to political pressures, so I asked them to clarify what was felt to be wrong about the previous treatment. After all, we've had roads for hundreds of years, so you would have thought the treatment in the national accounts would be pretty much settled by now. The ONS didn't want to answer this just yet. Apparently there is to be a briefing note on the subject on Monday which they have promised to copy me in on. This may also throw some light onto how the government is intending to talk its way out of sticking to the rules. I'll post anything interesting they send me.

Until then I'm working on the assumption that Gordon Brown has hinted strongly to the ONS that he would be made a happy man if a way were found for him to meet the golden rule, and the ONS has decided to oblige.