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HMRC internal manual

Business Income Manual

Measuring the profits (particular trades): Private Finance Initiative (PFI): accounting: FRS5 key factors

Where the PFI contract is to be accounted for under FRS5 Application Note F , those who prepare and audit the financial statements have to consider whether the PFI property is reported as the private sector operator’s fixed asset, or as a finance debtor, for accounting purposes (see BIM64075 onwards).

The key test involves them considering the extent to which the operator bears any variations in profits or losses on the property. In order to assist them FRS5 identifies a number of factors to consider, greater weight being given to those factors that are more likely to have a commercial effect in practice.

The factors are:

  • Demand risk. There may be genuine uncertainty about the level of use of a property. If the level of the unitary charge (the annual service payment) is linked to usage, this may be a significant factor in determining whether the operator bears the benefits and risk in the property. However, unitary charges do not often vary substantially with demand or usage. Where they do not, that is an indication that the purchaser bears the benefits and risks in the property.
  • Third party revenues. Where the operator relies on third party revenues, which may be uncertain, to cover all or part of its property costs this may indicate that it bears the benefits and risks in the property.
  • Who determines the nature of the property? Where the design of the property fails to meet the operating requirements of the contract, the party that bears the cost of rectifying the design faults may be a relevant indicator.
  • Penalties. The level of penalties, for periods when the property is unavailable or below standard, may be a relevant factor.
  • Changes in relevant costs. The party that bears the risk of changes in property related costs might also be relevant. If these are materially significant and have to be borne by the operator this may indicate that it bears the risk.
  • Obsolescence. The party that bears the risk that the property may no longer be required during the contract period may also be a relevant factor.
  • Residual value risk. Which party bears the risk that the value of the property, at the end of the contract, is different from that expected? For example, the operator may retain the property at the end of the contract, or transfer it to the purchaser at the then prevailing market price. This would indicate that the benefits and risks in the property lie with the operator. Conversely, if the property is to be transferred to the purchaser, or a new operator, at a substantially fixed or nominal sum, this indicates that the benefits and risks in the property lie with the purchaser. Options, either to purchase or transfer the property at the end of the contract, will require careful analysis.

HMRC officers should refer any questions concerning the application of FRS5 to their local compliance/advisory accountant.