Colleges face yo-yoing bottom lines with proposed accounting rules

There might be a few green shoots of recovery for UK plc but public services are set for austerity up to at least 2018. The college sector has felt the pressure of being outside the funding ring-fence protecting pre-16 education. In the middle of this decade, many colleges will take another set of blows with National Insurance increasing and Formula Protection funding ending in 2016. Like buses coming in threes, the college sector has another prospective blow – a new accounting Statement of Recommended Practice (SORP) for Further and Higher Education which radically (and adversely) changes the way that capital grants are treated.

The draft SORP has not yet been issued but we know what it will propose for college accounts from 2015/16 onwards. The SORP consultation website already outlines the changes on capital grants:

The revenue recognition rules will result in most capital grants being credited to the Income Statement, rather than to deferred capital grants on the balance sheet. Deferred capital grants recorded on balance sheets, and their subsequent release to the I&E Account, will no longer occur.

This change will result in more volatile surpluses and deficits.

Future Income Statements will no longer benefit from the credit arising from the release of deferred capital grants (currently c£xm per year), which will reduce on-going reported surpluses.

Whereas now capital grants are released as income gradually over the life of the buildings or other assets which they funded to offset the depreciation cost of the assets, under the SORP the capital grant is recognised as income in one go with the depreciation hitting the bottom line year after year until the asset is fully depreciated. The resulting volatility will be seen in ridiculously large surpluses coming along when a college gets a capital grant but then many years of surpluses being much lower (or deficits much higher) than otherwise.

Sometimes the size and/or frequency of those deficits will mean that colleges breach the financial performance requirements of the covenants on their loan agreements. Since the credit crunch it can be very costly to upset bankers – a covenant breach means that a loan is (theoretically) repayable immediately and, in practical terms, the interest rate can be cranked up.

What will this mean in practical terms? How volatile will the proposed SORP requirements make bottom lines? It’s hard to say exactly without a crystal ball. However, we can look at the most recently available college accounts for some idea of what this means.

In 2011/12 the operating surplus for the whole of the college sector was £141 million – the value of the capital grant releases was £143 million. So these capital grant releases are significant for the further education and sixth form colleges taken as a whole. But what about individual colleges?

In total there were 74 colleges with operating surpluses had capital grant releases larger than these surpluses. In most of these cases the SORP treatment would have led to an operating surplus. A similar number of colleges already in deficit would have had a much operating deficits.

One London college had an operating deficit of £193k in 2011/12 but the value of its capital grant releases was £2.6 million. Another college in the south east had a surplus of £53k in 2011/12 after benefiting from capital grant releases of £2.3 million.

Colleges will have different loan covenants to comply with. But the SORP changes are a nasty shock to even colleges with relatively permissive covenants dating from before the credit crunch.

This amounts to a ticking bomb under the college sector unless the drafters of the SORP can be persuaded to change their minds by the consultation period ending in October.