F4 Present practice is not to capitalise contracts for services. However, where a property is needed to fulfil a contract for services, present practice may require the property to be recognised as the purchaser's asset. (For example, this is the case for some take-or-pay contracts where the operator builds a specialist property with little alternative use.) The purpose of the analysis below is to determine:
(a) whether the purchaser in a PFI contract has an asset of the property used to provide the contracted services together with a corresponding liability to pay the operator for it or, alternatively, has a contract only for services; and
(b) whether the operator has an asset of the property used to provide the contracted services or, alternatively, a financial asset being a debt due from the purchaser.
F5 Under the general principles of the FRS, a party will have an asset of the property where that party has access to the benefits of the property and exposure to the risks inherent in those benefits. If that party is the purchaser, it will have a corresponding liability to pay the operator for the property where the commercial effect of the PFI contract is to require the purchaser to pay amounts to the operator that cover the cost of the property.
F6 In some cases the contract may be separable, ie the commercial effect will be that elements of the PFI payments operate independently of each other. 'Operate independently' means that the elements behave differently and can therefore be separately identified. Where this is the case, and where some elements relate only to services (such as cleaning, laundry, catering etc) rather than to the property, any such service elements are not relevant to determining whether each party has an asset of the property and should be ignored. A contract may be separable in various circumstances (see paragraph F10).
F7 Once any separable service elements have been excluded, PFI contracts can be classed into:
(a) those where the only remaining elements are payments for the property. These will be akin to a lease and SSAP 21 'Accounting for leases and hire purchase contracts' (interpreted in the light of the FRS) should be applied.
(b) other contracts ie where the remaining elements include some services). These contracts will fall directly within the FRS rather than SSAP 21.
F8 For those contracts that fall directly within the FRS, the question of whether a party has an asset of the property should be determined by looking at the extent to which each party would bear any variations in property profits (or losses). There are three important principles to be considered when undertaking such an analysis:
(a) A range of factors will be relevant in determining the extent to which each party would bear any variations in property profits (or losses) and it will be necessary to look at the overall effect of these factors when taken together.
(b) However, any potential variations in profits (or losses) that relate purely to a service should be excluded since it is only the property that may be included on the balance sheet of one of the parties, not the capitalised value of the whole service contract. Consequently, potential variations relating to the provision of services are not relevant to determining whether each party has an asset of the property.
(c) Paragraph 14 requires that, in determining the appropriate accounting treatment, greater weight should be given to those features that are more likely to have a commercial effect in practice. Where there is no genuine commercial possibility of a particular scenario or cash flow occurring, this scenario/cash flow should be ignored.
F9 The principles outlined above are considered in more detail below, under the following headings:
o Separation of the contract
o Should SSAP 21 or the FRS be applied?
o How to apply SSAP 21
o How to apply the FRS
Subsequently, the required accounting is explained.