Transition to ESA2010: Capitalising Government Spending on Military Weapons

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1 Transition to ESA2010: Capitalising Government Spending on Military Weapons Author: Peter Gittins Date: 10 June 2014 Executive summary This article covers the change to treatment of spending on military weapons that will be introduced when revised figures for the UK National Accounts, consistent with Blue Book 2014 and Pink Book 2014, are published in September The change is required under international standards and guidelines as a result of the implementation of European System of Accounts (ESA2010). At present, UK Government spending on military weapons is treated as current spending (Intermediate Consumption) in the National Accounts. Under the new UN system of National Accounts (SNA2008) and ESA2010 it is required to be treated as investment (Capital Formation). Weapons systems (broadly, planes, ships and tanks etc.) become fixed capital, whereas single use items (ammunition and bombs etc.) are treated as military inventories. The effect of this change on UK National Accounts and Public Sector Finances is described below. The conceptual change and the method used to create the ESA2010 consistent estimates are also described. The article does not provide a numerical assessment of the change, which is covered in the overarching article Impact of ESA10 changes on current price GDP estimates. 1 Introduction The UK National Accounts comply with international standards set out in the European System of Accounts (ESA), Balance of Payments Manuals (BPM) and the Manual on Government Deficit and Debt (MGDD). These standards ensure that economic statistics produced by all EU member states are compiled in a consistent, comparable and reliable way. Periodically, these manuals are reviewed to ensure that they continue to reflect economic and technological developments in domestic and global economies and meet user needs. The new ESA2010 introduces a number of new concepts, for example, the extension of assets to cover research and development and the weapons systems covered here. EU member states will also be required to produce data on liabilities related to pension systems. Office for National Statistics Page 1

2 The new BPM6 includes new measurement methods for foreign direct investment, gambling and for when businesses, as part of their production regime, send goods abroad for processing. The revised standards will change the way in which national accounts and balance of payments across the EU member states are produced, and bring them into line with the worldwide SNA2008, already adopted by other parts of the world, including Canada, the United States and Australia. One of the main changes as a result of ESA2010 is the capitalisation of spending on military weapons. This article provides a technical overview of methodology associated with this change. The article does not provide a numerical assessment of the change, which is covered in the overarching article Impact of ESA10 changes on current price GDP estimates. 1.1 Summary of the change to capitalise spending on military weapons Outline of the change At present, UK Government spending on Military Weapons is treated as current spending (Intermediate Consumption) in the National Accounts. Under the SNA2008/ESA2010 it is required to be treated as investment (Capital Formation). Purchases of weapons systems (broadly, planes, ships and tanks etc.) become fixed capital formation. These fixed capital items will then be consumed over a number of years (Capital Consumption). Purchases of single use items (ammunition and bombs etc.) become military inventories. Military inventories are still considered intermediate consumption when they are used. Military Inventories may also be stored until used (recorded as a positive change in inventories) or withdrawn from stock and used up (recorded as a negative change in inventories as well as intermediate consumption). The value of the change in inventories (acquisitions less disposals) is capital formation. The ESA2010 change does not affect the treatment of spending on military dual use equipment (defined in ESA1995 as structures and equipment used by the military similar to those utilised by civilian producers). This expenditure is treated as fixed capital formation under both ESA1995 and ESA Summary of Impact on national accounts and public sector finances For Gross Domestic Product (GDP), the change to intermediate consumption is offset by the change to capital formation. However, GDP is increased by the value of the additional Capital Consumption due to increased capital stock from the extra investment (Fixed Capital Formation) in earlier years. For Public Sector Finances, the impact is limited to the current to capital ratio. Surplus on current budget and net investment both being affected by the change but exactly offsetting for Public Sector Net Borrowing. Office for National Statistics Page 2

3 The technical detail of the change to both National Accounts and to Public Sector Finances is described below. 2 National Accounts concepts Government spending on Military Equipment is currently treated as Government Intermediate Consumption in the National Accounts (transaction code P.2). Under SNA2008/ESA2010 it is required to be treated as Capital Formation (P.5g). Weapons systems (broadly, planes, ships and tanks etc.) become fixed capital formation (P.51g), whereas single use items (ammunition and bombs etc.) become inventories (P.52). Specifically, these are new asset classifications weapons systems (AN.114) and military inventories (AN.124) in ESA2010. Detailed extracts from SNA and ESA defining the new capitalised items are included as Annex 1. The conceptual impact of this change in the main National Accounts aggregates (including GDP) and on Public Sector Finances is outlined below. The impact in National Accounts terms is largely based on Eurostat s Manual on the changes between ESA95 and ESA2010 (see pages 28 to 31). 2.1 GDP Output Approach Output of government (P.1) is measured by the sum of costs approach. That is: Intermediate Consumption (P.2); plus Compensation of Employees (D.1); plus Consumption of Fixed Capital (P.51c). Gross Value Added (GVA), which becomes GDP when converted to market prices, is equal to Output (P.1) less Intermediate Consumption (P.2) GVA = P.1 P.2 Where: P.1 = P.2 + D.1 + P.51c (i.e. sum of costs for non market output) Reclassifying current spending on military weapons as Capital Formation (P.5g) reduces Intermediate Consumption (P.2). For GVA, the pure Intermediate Consumption reduction is simply netted-off by the same reduction within the sum of costs approach to measuring output of government (P.1). Therefore, government GVA (and hence GDP) is changed only by the increased value of Capital Consumption (P.51c). This increased capital consumption is due to larger capital stock, from the extra Fixed Capital Formation (P.51g), in earlier years. Capital Formation is not a component of government output. Total government Output (P.1) must also be equal to: market output (P.11); plus output for own final use (P.12); plus non market output (P.13). The pure non market output (P.13) is therefore derived by residual. Office for National Statistics Page 3

4 Where: P.1 = P.2 + D.1 + P.51c (i.e. sum of costs for non market output) Also: P.1 = P.11 + P.12 + P.13 Therefore pure non market output (P.13) is derived as a residual: P.13 = (P.2 + D.1 + K.1) P.11 P.12 Sales of used weapon system assets are reported by government as Market Output (P.11). Reclassifying these sales as disposal of existing fixed assets (P.5113) would reduce market output (P.11) giving a larger Non Market Output (P.13) value, but again with no impact on GVA/GDP. These are relatively small values for the UK as reported by the Ministry of Defence (MoD). In fact, these sales of weapons systems have previously been reclassified by ONS to become negative Intermediate Consumption (P.2) in the UK National Accounts. They are therefore ignored for the purposes of this change. 2.2 GDP Expenditure Approach GDP Expenditure is the sum of: Final Consumption Expenditure (P.3); plus Gross Capital Formation (P.5g); plus Exports (P.6); less Imports (P.7). P.3 + P.5g + P.6 P.7 = B1*g (GDP) Final Consumption Expenditure of government (P.3) is equal to government non-market output (P.13), which is valued by sum of costs (see above). Since P.13 = P.3 the substituted formula for government expenditure is: (P.2 + D.1 + P.51c P.11 P.12) + P.5g + P.6 P.7 = B.1*g The reclassification of military weapons to Gross Capital Formation (P.5g) is therefore netted-off by the corresponding reduction of Intermediate Consumption (P.2) within the calculation of Government Final Consumption Expenditure (P.3). Consequently, GDP is again changed only by the increased value of Capital Consumption (P.51c) within the calculation of government final consumption. The reduction in the value of sales of weapons systems would reduce Market Output (P.11) and be netted-off by disposal of assets within Gross Capital Formation (P.5g). However, as explained above, these values are treated as negative intermediate consumption and can therefore be ignored for the purposes of this change. Gross Capital Formation (P.5g) is subdivided into three different categories of capital formation. It is the sum of: Gross Fixed Capital Formation (P.51g); plus Changes in Inventories (P.52); plus Acquisitions less Disposals of Valuables (P.53). P.51g + P.52 + P.53 = P.5g Office for National Statistics Page 4

5 The treatment of spending on military weapons within Gross Capital Formation (P.5g) is different, depending on whether the weapon can be used more than once. Purchases of weapons systems (broadly, planes, ships and tanks etc.) become Fixed Capital Formation (P.51g) under ESA2010. These fixed capital items are then consumed over a number of years i.e. as Capital Consumption (P.51c) which is described in section Single use items (ammunition and bombs etc.) become military inventories under ESA2010. At the point of disposal, military inventories are still considered Intermediate Consumption (P.2), representing ammunition used up in the production process (defence) during the year. Military Inventories may be stored until used, in which case they are recorded as a positive change in inventories (acquisition). They may also be withdrawn from stock (disposed), in which case they are recorded as a negative change in inventories (disposal) as well as Intermediate Consumption (P.2). The value of the overall stock change, acquisition less disposal, is the Change in Inventories (P.52) that is a component of Gross Capital Formation (P.5g). Change in Inventories does not give rise to capital consumption. The concept of Inventory disposals requires an estimate of both the value of used (fired) ammunition and the value of stock discarded due to obsolescence. For military inventories, not all of the value of spending currently treated as Intermediate Consumption (P.2) is actually transferred to Gross Capital Formation (P.5g). The value of ammunition consumed during the year remains as intermediate consumption. Only the value of Changes in Inventories (P.52) becomes gross capital formation. During periods of high ammunition usage (i.e. conflicts) inventory change could be negative, which means that the current intermediate consumption value would be increased with a corresponding decrease in gross capital formation (see worked example at Annex 2). This treatment of the Change in Inventories (P.52) element of the military weapons change is not explored in the Eurostat s manual on changes between ESA95 and ESA2010. However, it is covered in the UN Canberra II Group s recommendations to treat Military Weapons (see paragraphs 25 to 32). 2.3 GDP Income Approach GDP Income is increased by the impact on Gross Operating Surplus, which for Government is equal to Capital Consumption (P.51c). Therefore, in each of the three measures of GDP, the impact is limited to the increased value of capital consumption due to larger fixed capital formation in earlier years. Office for National Statistics Page 5

6 2.4 Public Sector Finances (Public Sector Net Borrowing) As described above, the impact of this change is to increase investment (capital formation) and hence capital consumption, whilst reducing current spending. Overall, the change will have zero impact on Public Sector Net Borrow (PSNB). Reclassifying current spending (i.e. intermediate consumption) to investment (i.e. capital expenditure) exactly offsets. Capital Consumption does not impact the value of overall PSNB. The impact is therefore limited to the current to capital ratio. For UK Public Sector Finances, the net investment value is increased by the difference between capital spending and consumption of fixed capital. Capital Consumption remains as current spending. Surplus on current budget is increased by the difference between the reduction in current spending and the capital consumption (which is used to adjust gross savings). These values are equal and therefore PSNB is unchanged as described above. Full details of the impact of all ESA2010 changes on the UK Public Sector Finances are included in the article Transition to ESA10: Update to Impact on Public Sector Finances released in February Data sources and methodology 3.1 Current approach The data source for most Central Government spending in the UK is the HM Treasury (HMT) managed OSCAR database. This database is updated with accounting data from all UK government departments. The disaggregated nature of this data source (data is available by department and by type of expenditure) means that the micro data for spending on weapons and ammunition is visible. Military expenditure data are entered into OSCAR by the Ministry of Defence (MoD) with metadata generated on, for example, ESA transaction code, budget category and COFOG (Classification of Functions of Government). Detailed OSCAR data are provided to ONS quarterly and processed for National Accounts and Public Sector Finances. In correspondence with HMT/MoD it was confirmed that the OSCAR data covering spending on weapons and ammunition was all recorded by MoD as SUME (Single Use Military Equipment). As expected, this spending is currently treated as intermediate consumption (P.2) in the Central Government sector of the National Accounts. Detailed investigation of processing systems highlighted that sales of used weapons systems are currently treated as negative intermediate consumption rather than as market output (P.11), which the raw OSCAR data suggested. Detailed data from the OSCAR database (and from its predecessor COINS) are available from 2002/03 to present. Earlier data are less detailed, which means that the SUME spending is somewhat less visible. However, it can be assumed that in all cases SUME expenditure has been classified as intermediate consumption (P.2). Office for National Statistics Page 6

7 3.2 New approach to be implemented in September 2014 The general estimation method outlined below includes a number of assumptions that, in time, the Office for National Statistics (ONS) may wish to refine and improve. This is necessary to implement the change within the timetable for producing the 2014 National Accounts. As described above, the basic micro-data for spending on military weapons was available in the COINS/OSCAR data. However, implementation of the ESA2010 treatment of this spending required additional data from MoD as well as application of modelling techniques to estimate historic data. In particular, it was necessary to calculate data back to 1963 (the start point of the existing government data) in order to create the capital stock levels that inform the calculation of consumption of fixed capital Calculating Acquisitions of Fixed Capital (P.51g and P.52 acquisitions) The available COINS/OSCAR data on purchases of SUME (2002/03 onwards) required additional data from MoD to differentiate between Military Systems and Ammunition. Military Systems become Gross Fixed Capital Formation (P.51g) and Ammunition becomes Military Inventories (P.52). ONS received five years of detailed financial year SUME purchases data from MoD/HMT. This included a split into capital (weapons systems) and inventories (ammunition) purchases. This annual purchases data matched existing raw data from COINS/OSCAR. Since the existing data matched the new data, the existing quarterly values were adjusted using the annual proportions (from the new data) to give weapons systems and ammunition quarterly purchases back to Q The proportion of weapons systems vs. ammunition is relatively stable in the new data received from MoD. Therefore, an average (90% weapons systems: 10% ammunition) has been used to apportion total SUME data in earlier years: For 2002 to 2008 this is actual SUME data - quarters extracted from existing COINS/OSCAR raw data files, which match annual data received from HMT/MoD. For 1987 to 2001 this is a total SUME value derived from 2002q1 SUME level using the Intermediate Consumption (P.2) Defence COFOG as an indicator series. For 1963 to 1986 this is a total SUME value derived from the (derived) 1987q1 value using total central government Intermediate Consumption (P.2) as an indicator series. This method gives Gross Fixed Capital Formation (P.51g) and Military Inventories (P.52) purchases (acquisitions) back to Some work has been completed to test whether this data should be quality adjusted in any way to account for periods with significant military action (e.g. Falklands War). However, no evidence was found to support further quality adjustment of the data Calculating Disposals of Fixed Capital (P.51g and P.52 disposals) ONS has SUME disposals data for 2002 to 2011 in the existing COINS/OSCAR raw data files. As explained above (in conceptual impact), this data is described by MoD as Market Output (P.11) but has been re-coded by ONS as negative Intermediate Consumption (P.2). Office for National Statistics Page 7

8 ONS also received some new data from MoD/HMT on sales of weapons systems, which broadly matched the existing data. These disposals are assumed to relate to sales of weapons systems only. However, the data is erratic and mostly of small value. This makes calculating a back series impossible, and it is therefore assumed that pre 2002 values are all zero. This is an area where ONS would ideally like to get additional data, but this is currently not available. Consequently, ONS has not sought to re-code the disposals data, currently used to make a reduction to Intermediate Consumption (P.2), as a disposal of an asset (P.5113). The value of disposals of existing fixed assets is effectively assumed to be zero and the value of Gross Fixed Capital Formation (P.51g) is equal to the value of acquisitions described above. This may serve to slightly overstate Capital Consumption (P.51c) in some cases. However, given the long asset life lengths and relatively small value of disposals, the impact is insignificant. MoD/HMT also provided five years of ammunition consumption data (i.e. value of ammunition discharged), but this was again annual (financial years) data only. Calculating quarterly inventories usage data (value of fired ammunition) is especially difficult because the data lacks a suitable indicator series to model from. The annual data, in 2008 to 2013, is therefore equally divided into quarters. The available ammunition consumption data includes one year with a significant military action (i.e. Libya in ). In the other years, the level of disposals (ammunition discharged) is at a fairly uniform level. Given this, ONS has implemented the following method for back-casting pre 2008 quarterly ammunition consumption values. In general, the average quarterly value for to and is revalued to historic prices using the Producer Price Index (PPI) for weapons and ammunition (Industry 84). For other quarters (e.g. covering the Falklands war and parts of the Iraq/Afghanistan conflicts), an average quarterly value based on the (Libya) data is used. This is again re-valued to historic prices using the PPI. A significant weakness in the available MoD data, for National Accounts purposes, is that it does not include any obsolescence values. ESA2010 requires that Inventories disposals should include obsolescence due to physical deterioration and that these disposals should be valued at time of disposal (paragraph 3.152(C) of the ESA2010 manual). Since MoD has not been able to provide any information on obsolescence, a modelled approach has been implemented in the calculation of inventory disposals. This assumes that 5% of purchases are made obsolete after 10 years and a further 10% are made obsolete after 15 years. This is an arbitrary calculation, with the timescale for obsolescence chosen by reference to MoD report and accounts for 2012/13, which states that the life length for small arms is 10 to 15 years. The Producer Price Index for weapons and ammunition has been used to revalue the purchases to time of disposal, as required by the ESA2010 manual. Although ONS recognises that life length of small arms is not a perfect indicator of ammunition life length, it is the best available source. ONS may seek to refine the assumptions used in this model over time. Office for National Statistics Page 8

9 3.2.3 Calculating the Change in Inventories (P.52) As described in section 2.2, Change in Inventories (P.52) is calculated by inventory acquisitions less inventory disposals (based on the acquisitions and disposals data described above). Change in inventories has therefore been calculated back to Using this approach, the derived closing stock value for 2012/13 is close to the valuation of munitions inventories from the MoD 2012/13 Report and Accounts (page 134) of 1,969 million. This effectively uses MoD Report and accounts as a broad check total, although recognising that there may be conceptual and valuation differences between the two values. In the National Accounts, the holding gains for military inventories have been set to zero Calculating the adjustment to Intermediate Consumption (P.2) The value of acquisitions of Fixed Capital Formation (P.51g) and Inventories acquisitions (as described above) are removed from the current Intermediate Consumption (P.2) values. The value of Inventory disposals (as described above) is added back to intermediate consumption. The value of any ammunition bought and disposed (fired) during the period remains as intermediate consumption Calculating the Consumption of Fixed Capital (P.51c) Estimates of Consumption of Fixed Capital (P.51c) in the National Accounts are made through use of a Perpetual Inventory Method (PIM). A PIM is an economic model that enables balance sheets (or stocks) to be calculated from the associated flows, a PIM separately models the stocks levels of various assets owned by different industries. The ONS PIM takes Gross Fixed Capital Formation (GFCF) investment data by industries and uses it to form estimates of the value of capital stocks in use in the UK. Assumptions about the life of these capital stocks are used to ensure that they are withdrawn from the model when they are no longer economically useful. For estimates of the consumption of fixed capital and net capital stocks these assets are written down over their lifetime. For gross capital stocks, the asset is valued at its new replacement cost until such time as it is retired. At any given point in time, the PIM estimates the constant price value of capital stocks still in use by summing the original investment data for these assets over their lifetimes. To measure net capital stocks, each year s investment is adjusted to reflect the consumption of fixed capital (depreciation). In the ONS PIM, straight-line depreciation is assumed, so that the stock of each year s investment decreases each year by a constant amount, falling to zero at the end of the asset s life-length. This is a depreciation profile based on a constant annual amount of capital consumption over the service life of the asset. This service life is the total period during which the asset remains in use or ready to be used, in a productive process, even if the asset has more than one owner. The depreciation of each asset and industry within each year is aggregated to provide the consumption of fixed capital measure. While an asset might have an average life length of 10 years that does not mean that all such assets are retired exactly 10 years after being purchased. In fact, it is likely that these assets will be retired over a period of a few years, with 10 being the average. To ensure that Office for National Statistics Page 9

10 the model reflects this, a retirement function is used where retirements of assets are assumed to be normally distributed around the mean asset life length. To model this, the parameters for the distribution of asset retirements are entered into the PIM. This is called the coefficient of variation for each asset. Introducing the new 'weapons systems' asset into the existing PIM required the following changes: The weapons systems asset has been introduced in the institutional sector central government and in industry 84 (Public Administration and Defence). New assumptions were required about the average life length of the weapons systems asset and its coefficient of variation. Initially, ONS considered using separate life lengths for the ships, aircraft and vehicles assets based on information in MoD s report and accounts. This would have required additional data on the value of purchases by type of asset that was not available. Consequently, ONS used an average life length for the weapons system asset of 20 years, which was based on the service lives used in the United States. The GFCF deflator for the weapons systems asset has been used. This is based on deflators for ships and boats and aircraft and spacecraft reflecting the major assets within weapons systems. Adding historic Gross Fixed Capital Formation (P.51g) data back to 1963 (described above) then allows the PIM to build up a time series of accumulated stocks and Consumption of Fixed Capital (P.51c) for the new weapons systems asset. 4 Impact of the changes This article does not provide a numerical assessment of the impact of the change. This can be found in the associated article Impact of ESA2010 changes on current price GDP estimates. In general terms, the following key National Accounts aggregates are affected: Gross Capital Formation (P.5g) within the government sector is increased Fixed Capital Consumption (P.51c) of government is therefore also increased Intermediate Consumption (P.2) of government is reduced by an amount equal to the increase in Gross Capital Formation Both Output of Government (P.1) and Government Final Consumption Expenditure (P.3) are reduced by an amount equal to the difference between the increases Capital Formation and Capital Consumption Gross Value Added and Gross Operating Surplus of Government both increase by the value of the new Capital Consumption, as does GDP. For Public Sector Finances, the change will have no impact on Public Sector Net Borrowing (PSNB). Surplus on current budget and net investment are both increased with changes exactly offsetting for PSNB. A numerical assessment of this change was included in the article Transition to ESA10: Update to Impact on Public Sector Finances released in February Office for National Statistics Page 10

11 5 Conclusions The method outlined above gives data of sufficient quality to be integrated into the National Accounts and Public Sector Finances in September Further work with MoD and HMT will take place in 2014/15 to refine the estimates going forward, and where possible make improvements to the back data. 6 Contact For further information contact Peter Gittins 7 Acknowledgments The author would like to thank colleagues across ONS for their contributions to this article. Particularly, Charlotte Gaughan for her work on modelling disposals of military inventories. Also, Wesley Harris for his work on calculating consumption of fixed capital. 8 References Eurostat Manual on the changes between ESA95 and ESA2010 UN Canberra II Group s recommendations to treat Military Weapons Office for National Statistics Page 11

12 Annex 1 Description of New Assets Source SNA08 - Summary of changes from SNA93 Text Extension of the assets boundary and government gross capital formation to include expenditure on weapons systems Reference: chapter 10, paragraphs and SNA08 Chapter 10 paragraph SNA08 Chapter 10 paragraph ESA 10 paragraph ESA10 definitions page 273 ESA10 definitions page 273 ESA 10 Chapter 20 paragraphs A3.55 The military weapons systems comprising vehicles and other equipment such as warships, submarines, military aircraft, tanks, missile carriers and launchers, etc. are used continuously in the production of defence services, even if their peacetime use is simply to provide deterrence. The 2008 SNA, therefore, recommends that military weapons systems should be classified as fixed assets and that the classification of military weapons systems as fixed assets should be based on the same criteria as for other fixed assets; that is, produced assets that are themselves used repeatedly, or continuously, in processes of production for more than one year. A3.56 Single-use items, such as ammunition, missiles, rockets, bombs, etc., delivered by weapons or weapons systems are treated as military inventories. However, some single-use items, such as certain types of ballistic missiles with a highly destructive capability, may provide an ongoing service of deterrence against aggressors and therefore meet the general criteria for classification as fixed assets. A3.57 Unlike in the 1993 SNA, strategic inventories are no longer separated from other inventories of the same type of products. A3.58 The 1993 SNA treated as gross fixed capital formation only those expenditures by the military on fixed assets of a kind that could be used for civilian purposes of production. On the other hand, military weapons, and vehicles and equipment whose sole purpose was to launch or deliver such weapons, were not treated as gross fixed capital formation but as intermediate consumption. Weapons systems include vehicles and other equipment such as warships, submarines, military aircraft, tanks, missile carriers and launchers, etc. Most single-use weapons they deliver, such as ammunition, missiles, rockets, bombs, etc., are treated as military inventories. However, some single-use items, such as certain types of ballistic missile with a highly destructive capability, may provide an ongoing service of deterrence against aggressors and therefore meet the general criteria for classification as fixed assets. Military inventories consist of single-use items, such as ammunition, missiles, rockets, bombs, etc., delivered by weapons or weapons systems. As noted above in the discussion of weapons systems as fixed capital, most single-use items are treated as inventories but some types of missiles with highly destructive capability may be treated as fixed capital because of their ability to provide an ongoing deterrence service against aggressors. Gross fixed capital formation includes the following borderline cases: a)... b) structures and equipment used by the military; c) light weapons and armoured vehicles used by non-military units; d)... Weapons systems (AN.114) Vehicles and other equipment such as warships, submarines, military aircraft, tanks, missile carriers and launchers etc. Most single-use weapons they deliver are recorded as military inventories (see AN.124) but others, such as ballistic missiles with highly destructive capability, that are judged to provide on-going deterrence against aggressors are classified as fixed assets. Military inventories (AN.124) Ammunition, missiles, rockets, bombs and other single-use military items delivered by weapons or weapons systems. Excludes some types of missiles with highly destructive capability (see AN.114). Military Expenditure Military weapon systems, comprising vehicles and other equipment such as warships, submarines, military aircrafts, tanks, missile carriers and launchers etc. are used continuously in the production of defence services. They are fixed assets, like those used continuously for more than one year in civilian production. Their acquisition is recorded as gross fixed capital formation, i.e. as capital expenditure. Singleuse items, such as ammunition, missiles, rockets and bombs are treated as military inventories. However, some types of ballistic missiles are regarded as providing an on-going service of deterrence and therefore meet the general criteria for classification as fixed assets The time of recording of asset acquisition is the time of the transfer of the ownership of the asset. In case of long-term contracts involving complex systems, the time of recording of the transfer of assets should be upon actual delivery of the assets, not the time of cash payments. If some long-term contracts cover in addition the provision of services, government expenditure should be recorded at the time of the provision of services, recorded separately from the provision of assets If military equipment is leased, the transaction is invariably recorded as a finance lease and not as an operating lease. This implies that the recording of an acquisition of military asset is matched by the incurrence of an imputed loan by the government lessee. As a result, payments by government are recorded as debt servicing, a part as repayment of the loan, another part as interest. Office for National Statistics Page 12

13 Annex 2 capitalisation of SUME worked example with illustrative data Current treatment year x SUME Purchases of 5bn all treated as Intermediate Consumption (P.2) ESA10 Treatment year x SUME Purchases of 5bn become: Weapons systems asset (P.51g) of 4.5bn Military Inventory acquisitions of 0.5bn Military Inventory disposals (discharge and obsolescence) of 0.3bn is (P.2) Change in Military Inventories (P.52) is calculated as 0.5bn - 0.3bn = 0.2bn In summary: SUME is treated as 0.3bn (P.2) and 4.7bn (P.5g) Note that P.5g = P51g + P.52 ESA10 Treatment year x (conflict) SUME Purchases of 5bn become: Weapons systems asset (P.51) of 4.5bn Military Inventory acquisitions of 0.5bn Military Inventory disposals (discharge and obsolescence) of 1.0bn is (P.2) Change in Military Inventories (P.52) is calculated as 0.5bn - 1.0bn = - 0.5bn In summary: SUME is treated as 1.0bn (P.2) and 4.0bn (P.5g) Note that under ESA10 the P.51g element here is consumed as Capital Consumption (P.51c) in subsequent years this is not covered in the worked example. Office for National Statistics Page 13

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