Treasury management strategy report 2016-17

In instances whereby local authorities have a positive capital financing requirement (CFR), they are required to set aside a minimum amount from revenue to fund the repayment of debt, this is known as the minimum revenue provision (MRP). This means that we would be required to pay off an element of the accumulated general fund capital spend each year (the CFR) through a revenue charge (the MRP).

Options for prudent provision of the MRP

Department of Communities and Local Government (DCLG) regulations and guidance have been issued which require the full council to approve an MRP statement in advance of each year. Four options for prudent provision of the MRP are provided to councils, these being:

Option 1 - regulatory method

For debt which is supported by the government through the revenue support grant system, authorities may continue to use the formulae in the current regulations, since the revenue support grant is calculated on that basis. Although the existing regulation 28 is revoked by regulation 4(1) of the 2008 regulations, authorities will be able to calculate MRP as if it were still in force. Solely as a transitional measure, this option will also be available for all capital expenditure incurred prior to 1 April 2008.

Option 2 - capital financing requirement method

This is a technically much simpler alternative to option 1 which may be used in relation to supported debt. While still based on the concept of the CFR, which is easily derived from the balance sheet, it avoids the complexities of the formulae in the old regulation 28 (though for most authorities it will probably result in a higher level of provision than option 1).

Option 3 - asset life method

For new borrowing under the prudential system for which no government support is being given and is therefore self-financed, there are two options included in the guidance.

Option 3 is to make provision over the estimated life of the asset for which the borrowing is undertaken. This is a possibly simpler alternative to the use of depreciation accounting (option 4), though it has some similarities to that approach.

Within option 3, two methods are identified. The first of these, the equal instalment method, will normally generate a series of equal annual amounts over the estimated life of the asset. The original amount of expenditure ('A' in the formula) remains constant.

The cumulative total of the MRP made to date ('B' in the formula) will increase each year. The outstanding period of the estimated life of the asset ('C' in the formula) reduces by 1 each year.

For example, if the life of the asset is originally estimated at 25 years, then in the initial year when MRP is made, C will be equal to 25. In the second year, C will be equal to 24, and so on. The original estimate of the life is determined at the outset and should not be varied thereafter, even if in reality the condition of the asset has changed significantly.

The formula allows an authority to make voluntary extra provision in any year. This will be reflected by an increase in amount B and will automatically ensure that in future years the amount of provision determined by the formula is reduced.

The alternative is the annuity method, which has the advantage of linking MRP to the flow of benefits from an asset where the benefits are expected to increase in later years. It may be particularly attractive in connection with projects promoting regeneration or administrative efficiencies or schemes where revenues will increase over time.

Option 4 - depreciation method

Alternatively, for new borrowing under the prudential system for which no government support is being given, option 4 may be used.

This means making the MRP in accordance with the standard rules for depreciation accounting. A step in this direction was made in the last set of amendments to the MRP rules (SI 2007/573). However, the move to reliance on guidance rather than regulations will make this approach more viable in future.

Authorities will normally need to follow the standard procedures for calculating depreciation provision. But the guidance identifies some necessary exceptions:

• the MRP continues until the total provision made is equal to the original amount of the debt and may then cease

• if only part of the expenditure on the asset was financed by debt, the depreciation provision is proportionately reduced

MRP policy in respect of finance leases

The introduction of the international financial reporting standards in 2011-12 resulted in some leases being reclassified as finance leases instead of operating leases. This resulted in a positive CFR and as such the need to set aside a MRP.

In accordance with the revised DCLG Guidance we will set aside an annual MRP equal to the amount of the lease that has been taken to the balance sheet to reduce the finance lease liability i.e. the principal amount of the finance lease. This approach will produce an MRP charge which is the same as option 3 in the guidance (asset life method - annuity method). The revised guidance aims to ensure that authorities are in the same position as if the change in accounting standards had not occurred.

MRP policy - other capital expenditure

Capital financing requirement (CFR)

Our CFR is currently negative. This means that there is no requirement to set aside a MRP for the redemption of external debt. The prudential indicator for the CFR, shown in the treasury management strategy, indicates that the CFR will become positive within the period covered by the strategy. This is based on the assumption that there will be a general overall increase in expected capital expenditure, which cannot be funded from revenue or capital resources. Accordingly, we need to determine the option it will employ to make the necessary MRP in respect of the amount borrowed, if this occurs.

Option for making MRP

The most appropriate of the four options permitted by the regulations is option 3, the asset life method, within which there are two further options, an equal instalment method and an annuity method of which the equal instalment method would be the more appropriate. This provides for us to make revenue provision over the estimated life of the asset for which the borrowing is undertaken, in effect the charge will be the amount borrowed in respect of the asset divided by the number of years of estimated life of the asset. It will result in an equal annual amount to be charged as MRP. Accordingly, if any borrowing does take place, this method of calculation of MRP will be used. It should be noted that MRP does not commence until the year following that in which the asset concerned became operational.