Changes to accounting standards for NHS organisations are having a significant impact on estates managers, affecting leases and restricting the capital trusts have available to invest

Changes to accounting rules for NHS trusts are proving a challenge for estates and finance directors as they impact on leasing agreements which were previously off capital balance sheets. 

The introduction of IFRS 16 for NHS trusts on 1 April 2022 has had far-reaching implications for already-tight NHS capital budgets and is leading to a rethink of how the health service utilises and expands its estate moving forward. 

The IFRS 16 accounting standard replaced IAS 17 with the intention of providing greater transparency in financial reporting. 

However, under the earlier standard, leases were classified as either ‘operating leases’ or ‘finance leases’ and the former did not impact NHS trusts’ Capital Departmental Expenditure Limits (CDEL), which restrict what public sector bodies can spend in terms of capital on an annual basis. 

Under IFRS 16, leases which satisfy the tests set out under the accountancy standard and do not fall within one of the limited exceptions are now accounted for on the balance sheet.  

And this change has restricted the cash that NHS trusts can invest in buildings and equipment, as the full value of any leasing arrangement caught by IFRS 16 will now count towards their CDEL.  

Challenging times

Speaking to Healthcare Property, Lisa Geary, health property partner at international law firm DAC Beachcroft, explains: “The NHS leases numerous buildings – particularly in mental and community health services – and under this accounting treatment many of those leases which used to be off balance sheet will now sit on the balance sheet, impacting the amount of capital the NHS has to spend on maintaining and improving its estate. 

“And not only does it impact leases creating a landlord and tenant relationship, but also some contracts where the ‘right to use’ an asset is granted and certain other tests are satisfied.” 

Stan Campbell, partner and health property lead at DAC Beachcroft, adds: “In broad terms, this means that under IFRS 16 a trust entering into a lease incurs a charge against its CDEL limit based on the length of the term and the value of the rent in the financial year in which that lease is completed. This restricts the actual cash a trust can invest in buildings and equipment.  

“And, of course, the consequences of IFRS 16 are greater for higher rents and longer leases.”  

A get-out clause

The exemptions available under IFRS 16 can mitigate its effect, including where leases are of low value or taken for a short term (12 months or less).  

However, where the NHS is a tenant, these exemptions are largely non applicable as many of its occupational commitments are for periods of more than a year and are often linked to service contracts. 

Geary says: “A trust may decide to take a series of shorter-term leases – possibly including tenant options to renew – to bring the lease arrangements within the short-term exemption, but care and advice needs to be taken here.  

“If it is ‘reasonably certain’, taking account of the surrounding circumstances, that a tenant will extend a lease – for example if they are making capital improvements to the building or entering into a services contract linked to a building for a longer period of time, both of which evidence an intention to stay in the building long term – and it may mean the exemption will not apply.”  

Protecting budgets

The effect of IFRS 16 has increased the pressure on trusts to look at other ways to protect their capital budgets and mitigate its impact. 

A significant proportion of the capital investment in the NHS estate to date was secured via the now-defunct Private Finance Initiative (PFI) approach. 

First introduced in 1992, the model involved private companies providing funding for the construction, refurbishment, and maintenance of NHS facilities in exchange for a long-term contract to deliver services.  

The private companies receive regular payments from the NHS over the duration of the contract, typically 25-30 years.  

This allowed private investors to generate a return on their investment while also delivering vital healthcare services to the population and enabled the NHS to keep the payments off balance sheet. 

However, the current Government stopped using the PFI model in 2018 and many of the existing contracts will come to an end between 2030-2050.   

The next step

One attempt to raise private capital for infrastructure projects was the Regional Health Infrastructure Companies (RHIC) scheme conceived by Community Health Partnerships (CHP), which aimed to fundraise in a similar manner to the Local Improvement Finance Trust (LIFT) initiative, but for larger projects, though smaller than those previously-agreed using PFI.  

While the scheme was scrapped before it took off, a primary benefit was its intention to account for costs on an off-balance sheet basis, meaning projects would not be included in the NHS’s capital spending limits.  

Campbell says: “One solution to the lack of capital for the NHS estate could be the creation of a Government-backed structure that would encourage private investment in healthcare infrastructure.  

“There are an increasing number of investors interested in ‘doing well by doing good’ by investing in the UK’s health and social care infrastructure.  

“With the strong covenant strength of the NHS, such a structure could provide the necessary reassurance to encourage private investment.” 

However, at present, it remains unclear whether the Government will create a replacement for PFI or establish an alternative avenue for private investment.  

And the recent introduction of IFRS 16 has only made funding the NHS estate more challenging.  

Space utilisation

“We know from conversations with our clients that many NHS bodies and their finance teams would welcome a more-simplified route to infrastructure funding,” says Campbell. 

Geary adds: “Trusts should ensure they seek reliable accountancy advice on the value of the buildings they own and those that they lease, including how they can legitimately mitigate any value going on balance sheet depending on the terms of the lease.  

“Estates managers are already working hard to ‘sweat their assets’ by looking at how existing space can be used more efficiently, and identifying surplus land for sale or reletting for income generation purposes.  

“The impact of IFRS 16 has further heightened the importance of doing this if it means that the leased estate can be reduced without any effect on the provision of quality care.  

“There is underutilised space in the NHS estate and if some of these leases can be brought to an end and space used more efficiently, then this can help. 

“Collaboration is key to this. The consolidation of space and an increased use of buildings which are shared with other public sector bodies can help to mitigate the value of leasing arrangements which sit on balance sheet by reducing a trust’s leasing footprint.” 

But, with a General Election on the horizon, many NHS trusts are hoping that whichever party gets into power decides to change the rules around IFRS 16 and/or CDEL limits. 

Campbell says: “If we see a change of Government in July, one of the Labour Party’s plans is for more people to be treated in the community.  

“Any required premises are likely to be leased and come onto the balance sheet under IFRS 16 unless a change of Government also comes with a will to change either accountancy treatment or the control of capital expenditure. 

“Whatever happens, the NHS is heading towards more primary and community care, rather than hospital-based care, so it will need to take on new buildings. 

“And key questions remain: how will estates be funded going forward? Will there be a replacement for PFI? Will an alternative avenue for private investment be created? Will investment be purely taxpayer-funded?  

“Only time will tell.”