“Simple, clear purpose and principles give rise to complex and intelligent behaviour. Complex rules and regulations give rise to simple and stupid behaviour.”
Visa credit card founder Dee Hock’s comments could be applied to our school funding system today.
I’ve had a frustrating insight into some of the stupidities created by a complex system in recent months while working on behalf of a multi-academy trust.
The trust wants to take advantage of its catering contractor’s offer of investment to upgrade the equipment in one of its school kitchen and dining facilities. It’s effectively an interest-free loan over the term of the catering contract.
Because the revenue generated by the improvements is guaranteed to far exceed the loan in the first year the trust would be able to balance its books and invest the extra cash in urgent maintenance and repairs to its schools – as well as extra counselling and support for children who aren’t funded by EHCPs.
The trust and its pupils win, and so does the catering contractor. It’s a no-brainer, isn’t it? But after some investigation I’ve learned that it isn’t actually allowed.
According to the ESFA, deals like these can’t be entered into because they are considered to be embedded finance leases under the UK’s Financial Reporting Standards and hence a form of borrowing.
I batted questions over to the ESFA over a period of several weeks in an effort to get a definitive answer about their policy on finance leases because the Academies Financial Handbook appears to be misleading.
Take a look at section 5.25 which states that trusts must seek the ESFA’s approval prior to a range of leasing actions: “taking up a finance lease on any asset for any duration from another party” is top of the list.
We contacted ESFA for that permission but learned that while the more costly operating leases are permitted for such investments, finance leases are not.
The ESFA says that HM Treasury is not content with any academies or multi-academy trusts (or Local Authority schools) borrowing – apart from specific government-approved initiatives such as the Salix energy efficiency scheme and public works loans for new school buildings - and agree to it only under “exceptional circumstances”. The decision appears to be driven by the government’s desire to keep long term borrowing off its books.
According to the rules, the choice for schools wanting to make investments like these is either to use a more expensive operating lease or invest capital funds. And digging into the bank account is not a possibility for many schools.
The fact is that these embedded finance leases have been going on for a long time and help to boost budgets in the current climate. Hundreds of schools have entered into these leases as part of contracts for everything from catering equipment and minibuses to mobile phones, representing several millions of pounds of investment – investment now lost to the sector.
Allowing schools to pursue embedded finance leases like these would be a significant way to reduce funding pressures and improve the lives of pupils. Blocking them will just create problems.
Even auditors had not been aware of this problem, although they are picking up on it now. During recent academy audits, several have reported academies to the ESFA for regulatory breaches, as entering into a finance lease without the ESFA’s approval is ultimately a breach of the trusts funding agreement.
The ramifications of this are potentially serious; while the ESFA could impose a financial notice to improve, the most likely scenario is forcing the academy to pay back the funding provided so as to “remove” the embedded lease issue – which then could risk putting their reserves into deficit in some cases. Academies may also have to endure additional scrutiny from the ESFA and a possible visit from the Regional Schools Commissioner or a Schools Resource Management Advisor. There’s also the reputational fallout, which could result in falling rolls – and further funding cuts.
The accounting treatment for leases is set for changes for the 2019/20 academic year with the introduction of a new international accounting standard on leasing. While this change will affect Local Authorities and the DfE’s consolidated academy sector report and accounts, as these both follow internal accounting standards, individual academy trusts will still follow the UK accounting standards as these are unlikely to adopt the new leasing changes for several years. The effect of the new standard is that most operating leases will need to be included on the balance sheet which then begs the question of how the DfE is going to deal with the differing requirements and treatment across the sector.
I’m now urging the powers-that-be to clarify their misleading guidance regarding embedded finance leases - and review their policy.
I’ve also asked them to proactively communicate the position to all interested parties including schools, procurement consultants, auditors and lawyers. Most importantly, they need to inform catering contractors many of whom, it appears, have taken the position that until ‘officially notified’ by government they will continue as they have always done in the past.
In the meantime, we’ve warned our clients off embedded finance leasing until we have that clarity and know where we stand.