20/08/2008 LEASING
LEASING USE OF LEASING FOR THE ACQUISTION OF SCHOOL EQUIPMENT These notes are designed to assist schools that are considering the use of leasing facilities for the acquisition of school equipment as an alternative to outright purchase. THE PRUDENTIAL CODE 2004 With effect from 1st April 2004 the previous regulations governing leasing for local authorities under Regulation 20 of the Local Authorities (Capital Finance) Regulations 1997 Statutory Instrument No. 319 were revoked. From the 1st April 2004 the Local Government Bill 2003 became effective. The Bill introduced the requirement for all Local Authorities, Local Education Authorities, Fire Authorities, Police Authorities and Schools to adopt the new Prudential System. This is a system of self regulation and accounting practice rather than one based upon central control via legislation. The system is based on two main criteria;- Prudence Affordability The basis of the self regulation is The Prudential Code for Capital Finance in Local Authorities and the basis of Accounting is The Local Authorities (Capital Finance and Accounting) England Regulations 2003. The Prudential Code has a number of objectives to demonstrate;- That capital expenditure plans are affordable That any external borrowing is within prudent and sustainable levels Good practice and Best Value for money Accountability A proper option appraisal has been carried out 2
ACCOUNTING POLICIES The Local Authority (Capital Finance and Accounting) England Regulations 2003 have revoked the previous lease/credit arrangement rules. The new regulations have identified that UK GAAP Accounting Policies are to be followed and details of how this affects the classification of leases is contained within the Local Authorities Statement of Recommended Accounting Practice 2004 (SORP) The SORP highlights the requirement to follow the current UK GAAP Accounting Policy for the classification of lease arrangements. This lease classification is contained within the Statement of Standard Accounting Practice 21 (SSAP21) and Financial Reporting Standard 5 (FRS5) SSAP21 & FRS5 In summary the statement and standard provide details of what a Finance lease is and what an Operating lease is. Finance Lease;- A lease that transfers substantially all the risks and rewards of ownership to the lessee (i.e.) a school Presumption is based on a Present Value (PV) test (normally 90%), known as the 90/10 rule. The test can be overridden where the substance is different from the form Operating Lease;- Any lease that is not a Finance lease In simplistic terms SSAP21 is a mathematical rule to establish lease classification; lease rentals are discounted at the implicit rate. When the lease rentals are discounted if the Net Present Value (NPV) is over 90% of cost then it s a Finance lease, if under 90% it s an Operating lease. FRS5 is a further assessment which checks the spirit of the lease and not just its financial mechanics, it assesses its substance not just its legal form. FRS5 looks at the parties intentions at the outset of the lease. The table below demonstrates the principles. 3
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WHAT IS AN OPERATING LEASE? It is a contract between a lessee (school/local authority) and a lessor (finance house or bank) giving the lessee use of an asset on payment of rentals over a specified period. The lessor retains ownership of the asset so that it never becomes the property of the lessee. This type of leasing arrangement can be treated as 'off balance sheet' for accounting purposes. When calculating the rentals on an operating lease, the residual value of the asset is taken into account. This significantly reduces the rental cost to the lessee. There may be an option to extend the leasing period at the end of the contract period. WHAT IS A FINANCE LEASE? A finance lease is similar in the sense that it is a contract between a lessee and a lessor. It allows the use of an asset throughout its useful working life without ultimately owning it. At the end of the lease agreement there are normally two options, either continue to use the asset by simply paying nominal rentals, or sell it acting as agent for the lessor and benefiting from a proportion of the sale proceeds. This type of lease is often known as a capital lease and for accounting purposes is on balance sheet. USING OPERATING LEASING WITHIN THE PLYMOUTH LEA Schools within the Plymouth City Local Education Authority MUST use Operating Leasing finance. There are a number of reasons for this;- No Capital Investment This is a major advantage to Plymouth City Council LEA as this form of leasing does not score against the Councils Credit Financing Requirement (CFR). The Council do not wish that any lease funding is arranged that would score against the CFR (i.e.) a Finance lease. It does not require Secretary of State Approval which is also a requirement of Finance Leasing. All rental payments made are viewed for accounting purposes as revenue items. Schools must when considering an Operating lease ensure that Return Conditions are appropriate and relevant to the use of the equipment being financed. Examples of return conditions to be mindful of are: Mileage check excess mileage levels (vehicles only) Location most lease agreements will not specify where an asset is to be returned at the end of the primary period. Normally an agreement will say anywhere within a 180 mile radius of the lessee s principal offices or anywhere in the UK. The lessee is responsible for any delivery costs. 5
Condition a clause will normally be found which states that the asset must be returned in a reasonable state, subject to wear and tear. This places an onus on the school to ensure that the asset is in a fit condition. Tracking or Location Do not lose smaller assets such as PCs; keep a record of their movements, who has them etc. In the event that an asset cannot be found the lessee will have to reimburse the lessor the value that the lessor would have realised from its disposal. All of the above can individually or collectively add to the overall cost of a lease by presenting the school with a bill at the end of the primary period. These return conditions can be negotiated prior to the inception of the lease but any dilution in their effect may result in higher rentals during the primary lease period. Assessing the costs of maintaining the asset in the return condition should be part of the option appraisal process. (See 1.8) Secondary Rentals At the expiry of the primary period the lessor can offer the school revised terms for the continued use of the asset. The setting of these rentals is at the discretion of the lessor. It is imperative that the authority practices good asset management, so that the assets can be handed back in reasonable condition at the end of the primary period. If it is appropriate and it offers value for money, one possibility would be to enter into a secondary rental period. Indicative rentals can be obtained at the time of quotation for the leasing finance from the lessor. This follows the practice within the guidance notes on Operating leasing offered by The Chartered Institute of Public Finance Accountants (CIPFA). All secondary rentals must be based upon current market values of the asset as outlined within the Finance & Leasing Association s Code of Practice for funding Local Authority leasing. HOW TO ARRANGE A LEASE 1. Identify a Supplier The first step is to identify a reputable supplier of the equipment required. Schools must adhere to the Financial Regulations for Schools Regulation 5.2 which requires that quotations be obtained from more than one supplier before expenditure estimated at over 2,500 is incurred on any one item and, where expenditure exceeding 12,000 is to be incurred, written tenders must be invited from not less than three suppliers or contractors. 6
Identify a Finance Company / Lessor The next step is to identify a suitable finance company or lessor. In the first instance schools can choose from a list of pre-approved lessors to Plymouth LEA that can offer operating lease facilities to schools Alliance & Leicester Commercial Finance Ltd AssetCo Barclays Asset Finance Citicapital Ltd Co-Operative Bank Plc GE Capital Investec Plc Siemens Financial Services Ltd Societe Generale Vendor Finance Ltd Syscap Plc It will be up to the individual school to seek quotations based upon the capital value of the equipment to be leased and the number of years of the lease. See reference to 1.8 www.capitaeducation.net OPTIONS APPRAISAL Before any lease arrangement is agreed or signed schools MUST demonstrate that the financial commitment is affordable and that a suitable Business Plan and Option Appraisal exercise has been undertaken and submitted to Plymouth LEA for prior approval. Schools will need to demonstrate the following:- That on-going lease rental payments can be met within their annual budget That an Operating Lease is the chosen product to use A SSAP21 90/10 Test has been evaluated as having a NPV less than 90% That a minimum of 3 quotations have been received from suitable lessors for consideration and best value evaluation, that include indicative secondary rental profiles. That suitable documentation has been considered to cater for return conditions Plymouth LEA schools can access www.capitaeducation.net to seek further support and guidance on all leasing and option appraisal matters or contact Capita Asset Funding Solutions direct on 0870-191-6888 for assistance. 7
WHAT ASSETS CAN BE LEASED? Permanent fixtures and buildings cannot be subject to a lease but a wide range of moveable assets can be leased, for example;- Classroom furniture and fittings Staff furniture and fittings ICT equipment and peripherals Photocopiers and printers Communications telephone and fax Laboratory and workshop equipment Sports and gymnasium equipment Domestic science equipment Storage and lockers Audio visual equipment Musical instruments Craft design and technology Security systems Coaches and minibuses Mowers and Tractors LEASING ICT EQUIPMENT Schools which are considering the acquisition of ICT equipment are advised to contact Plymouth City Council s Information Systems Division who can advise on the supply. For further information please contact Client Services on (30) 4424. It should also be noted that many suppliers offer a Total Solution or Managed Service product for ICT equipment which will often include (hardware/software/licences/maintenance/training/consultancy) it is important the any rental offer made to a school meets the requirements of SSAP21. Obsolescence This is a particular issue for ICT assets. The pace of change in this arena is very fast. As such the school will normally have acquired the state of the art machine at the outset only to find that within a short time it has been superseded. This can cut both ways, since it may in practice be possible top return round assets under operating leases more often than assets which are purchased. There are asset finance / leasing products on the market that attempt to take this issue on board. Schools need to assure themselves that any provisions for updates do not alter the nature of the lease. For further guidance contact either Plymouth LEA or Capita Asset Funding Solutions on 0870-191-6888 8
LEASING VEHICLES Schools which are considering obtaining vehicles are advised to contact the Transport Division who can provide vehicles under their existing Fleet Hire arrangements. This would cover all legal, health and safety, service and maintenance, tax and insurance requirements. However, if schools wish to make their own leasing arrangements, these would be the school s responsibility. Contract Hire is another alternative in acquiring a vehicle, this type of contract also requires a SSAP21 90/10 test to be evaluated. For further information on vehicles contact Contract Co-ordinator on (30) 4700 or for information on all asset finance and leasing issues contact Capita Asset Funding Solutions on 0870-191-6888. SUMMARY & CONCLUSION The issues surrounding the use of Operating leasing can be complex and a full assessment of whether or not to lease equipment should be made with due regard to the type of asset concerned. Each deal should be assessed on its own merits, and schools should carry out a full analysis of the various financing options before making a decision to lease. There should be a clear decision making process, which demonstrates compliance with regulations and ensures that, the proposed solution offers value for money. 9
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