SUMMARY/PURPOSE

1. At the meeting on 22 November 2005 the Cabinet received a Financial Exception Report for the period to 31 October 2005. One of the decisions taken at the meeting was to refer to this Committee a report assessing the risks associated with capital programmes spending significant sums in advance of funding being secured. This report provides the background to the issue and makes recommendations to how such expenditure should be managed effectively in future.

BACKGROUND

2. The Code of Practice on Local Authority Accounting in the UK (SORP) sets out a definition of capital expenditure with which all local authorities are obliged to comply. Basically, expenditure on the acquisition of a tangible fixed asset, or expenditure which adds to the value of an existing asset, should be treated as capital expenditure and classified as a tangible fixed asset provided that it yields a benefit to the authority for more than one year. A definition of capital expenditure is set out in Appendix A.

Preparatory Costs of Major Schemes

3. In local authority terms, for specific large capital projects, particularly infrastructure projects, there may be a requirement for a considerable amount of investment in a project prior to its submission to a Government department for formal approval. This can involve option appraisals, feasibility studies, consultation exercises, public enquiries and advance scheme design. The SORP specifically states that such costs are ineligible to the extent that they relate to activity that takes place before the intention to acquire or construct a particular fixed asset has been confirmed, unless they contribute to the scoping of the asset ultimately acquired.

Major Highway Schemes

4. The most significant projects in the highways capital programme are those for Ryde Interchange (£5.56m) and Undercliff Drive (£12.88m). The projects were approved in principle as part of the LTP settlements for 2003/04 and 2004/05 respectively. However, in both cases the point was made by the Department for Transport that acceptance was provisional only and subject to completion of all relevant statutory processes. Furthermore, funding allocations need to be confirmed each year, and Ministers reserved the right to reconsider their decision if the outcome of the statutory processes leads to any significant changes in the scheme. There is no guarantee on meeting any increase in costs over and above the Government’s agreed total contribution.

5. Details of the Council’s annual LTP allocations from the DfT are shown in Table 1 on Appendix B. Tables 2 and 3 on the Appendix show the approved budgets for the two major projects and details of expenditure and commitments to date. It can be seen from the information included in the Table that in terms of budget impact each of the two major schemes requires a significant investment when compared with the annual capital programme for the remainder of the highways and public transport network. Given that context, at the time the DfT had issued guidance with regard to preparatory costs for major schemes. It is a generally accepted principle that local authorities must take the additional risk of developing major schemes in order to demonstrate a genuine local commitment to it. In order to restrict such works to realistic schemes the DfT will consider the provision of funding for preparatory costs only after a scheme has been fully accepted. Fully accepted means the scheme has passed all the Government’s appraisal tests as well as all necessary statutory and planning procedures, and any other conditions. Eligible preparatory costs considered for approval would include detailed design of the scheme and work on preparing the scheme appraisal for submission to the DfT.

6. Since the projects were provisionally accepted, the Dft have issued further guidance for major schemes, which is specifically for schemes submitted after July 2005, but which GOSE believe the DfT plan to apply to all provisionally accepted schemes still not fully approved. In our case that would include both Ryde Interchange and Undercliff Drive. The major change is with regard to the approval process which now has three stages. Provisional approval of a project is now called Programme Entry, although the definition is much the same. A new intermediate approval stage is introduced at the point where full approval would previously have taken place. This is known as Conditional Approval and is a commitment to funding, subject to the cost estimates and risks remaining unchanged and the scheme being ready to commence within a certain period. Full Approval will not now be given until procurement has taken place and prices and risk allocation are known. Any application for Conditional or Full Approval must contain a full explanation of any cost increases, including the extent to which this was due to circumstances within, or not within, the authority’s control. The DfT will expect the authority to make some contribution to major scheme cost increases from their own resources, but also to provide the likely impact this will have on the wider capital programme. The final point in the revised guidance is that if a scheme is presented for Full Approval with a significant cost increase or a substantial design change, Full Approval may be denied or delayed, especially where the scheme no longer appears to represent sufficient value for money.

Coast Protection Schemes

7. Major coast protection schemes are one type of infrastructure asset where preparatory costs tend to be incurred. Currently, advance design costs are incurred prior to the schemes’ approval by DEFRA. Coast protection projects tend to be approved on a project by project basis and, up to now, DEFRA approval of such schemes has recognised the full costs of the scheme, thereby allowing grant and borrowing approvals to be applied to the advance design fees retrospectively.

Property Assets

8. The Council has a considerable property portfolio, including schools, leisure sites, fire stations and office accommodation. In terms of annual capital investment the most significant part of the capital programme tends to be for expenditure on schools development and major maintenance. There has been increasing slippage of capital projects in recent years, particularly in aspects of the schools programme including devolved capital budgets, the Middle Schools programme and to a lesser extent the Primary Schools programme. In a report on the Financial Health of the Council, the Audit Commission have noted that point, and suggested that the capital programme has become too ambitious and is driven by available resources from the Government rather than Council priorities, which has tended to lead to further underspends. As one of their recommendations for improvement, they have suggested that a solution to this problem is to create an inventory of projects which have been designed in advance in order that they can be substituted for delayed projects, thereby allowing the best possible use of available resources.

OUTCOME OF CONSULTATIONS

9. Consultation on this report has been undertaken with representatives of Engineering Services, Property Services and Children’s Services. The views of the Audit Commission have also been sought on the broader issue of reporting on the Council’s capital programme, and recent comments on the Council’s Use of Resources self-assessment make it plain that the Audit Commission view the provision of relevant, up to date financial management information to an appropriate forum of elected members as a key element of effective performance management.

FINANCIAL IMPLICATIONS

10. There are a number of financial implications arising from the information contained within this report. Clearly there is a risk to the Council’s financial well-being associated with having to invest sums of money in projects well in advance of formal Government approval of the project, particularly when the project is one of the magnitude of Undercliff Drive and the amounts in question are well in excess of £1.5 million. Such an investment requires positive budget management but, even so, it will inevitably have a detrimental impact on the ability to deliver other projects in the period until all necessary procedures have been completed and the Government release the approved funding for the project.

11. By contrast, continued slippage in aspects of the capital programme also has financial implications in terms of the use of resources available to fund the projects, but also that continued slippage of approved projects to a significant degree represents a threat to the effective delivery of the Council’s objectives.

12. Previous Government capital settlement methodology may have had an impact on the planning of schemes in advance to the extent that the settlements were for one year only, with no guarantees of future funding. It is anticipated that relaxation of Government controls in terms of the Prudential Code for borrowing, together with the implementation of three year settlements from 2006/07, will allow better asset management by affording the ability to plan capital programmes for an extended period with prior knowledge of available resources.

LEGAL IMPLICATIONS

13. There are no legal implications arising from this report. The report is the outcome of a quarterly performance management report to the Cabinet and, as such, is internally generated. The Council has the ability to choose how to improve the financial management of expenditure in advance of external funding being secured in order to ensure best use is made of available resources.

OPTIONS

1. To take no further action.

2. To recommend to the Cabinet that all capital projects should be evaluated in accordance with the Council’s risk assessment process; that all capital projects which are judged as medium or high risk having undergone the process should be recorded in the Council’s risk register to acknowledge the impact they can have on both the Council’s financial well-being and delivery of the Council’s strategic objectives; that all such projects recorded in the risk register should be the subject of regular progress reports (via the quarterly financial exception reports) in order that members are kept up to date with all aspects of project delivery; that all major capital projects should be subject to a Gateway review process in order to provide assurances as to progress through the various project stages up to and including procurement processes, and to include value for money considerations to ensure that the project continues to offer good value for money for the Council.

3. To recommend to the Cabinet that where appropriate, resources should be made available for advance design works in order that an inventory of projects is available to replace those delayed for any reason.

RECOMMENDATIONS

14. Option 2 and 3

BACKGROUND PAPERS

15. Code of Practice on Local Authority Accounting in the United Kingdom – A Statement of Recommended Practice

Guidance to Local Authorities Seeking DfT Funding for Transport Major Schemes

Audit Commission Report – Financial Health, Isle of Wight Council, Audit 2004/05

ADDITIONAL INFORMATION

16. None

APPENDICES ATTACHED

17. Appendix A – Definition of Capital Expenditure.

18. Appendix B – Tables of LTP Settlements and Major Schemes Budget and Expenditure

Contact Point: Stuart Fraser, Accountancy Services Manager ( 823657, email: [email protected]

STUART FRASER

Accountancy Services Manager