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We need to develop an appreciation for depreciation - Ian Pryce
Last year, the newspapers wrote about leaked information from the Department for Education, where senior officials were reportedly bemoaning the crumbling condition of our state schools, noting “the deterioration of the school estate continues to be a risk… (with) some sites a risk to life, too many costly repairs rather than rebuilds, and rebuild demand (outstripping) supply”.
It is standard accounting practice that your accounts reflect the costs of your activity. Capital investment is lumpy, so those costs are spread across the life of an asset and labelled “depreciation”. Depreciation is a real cost and reflects the diminishing value and quality of your buildings and equipment.
Failure to recognise this deterioration stores up all sorts of problems, not always immediately obvious. For public services in particular this can be catastrophic or even, as the DfE officials noted, a “risk to life”.
Many of the current problems in the NHS reflect a failure to invest. Former government adviser Sam Freedman tweeted that “we have seriously underfunded capital investment, preventative care and social care, while being repeatedly forced into increasing funding for acute care”. The Nuffield Trust reached similar conclusions last October. They showed that health spending is broadly comparable to other western countries as a proportion of GDP, though slightly lower when expressed as spend per person. However, we have a very different pattern of spending, with very low investment in buildings and modern equipment.
Similarly, in education, we tend to ignore depreciation, and we are now seeing how serious an error that is. Schools and academies do not own their buildings. Their balance sheets do not therefore include those fixed assets, or their depreciation. Buildings are treated as rent-free accommodation. Schools and academies can spend all the money they are allocated and break-even, when in reality they have consumed far more resource than they are showing. Unless government as landlord maintains your school, the quality of your accommodation will get worse, and it is a fair bet that government will not commit to sustained capital investment in this way. The result? Some schools that now pose a risk to life!
The college incorporation model of 1992 is superior to the academisation model, because buildings transferred to our corporations. Our accounts reflect the depreciation of our buildings. If we break even, this will be after taking account of depreciation, so colleges naturally generate cash to maintain the quality and value of their estate.
Sadly, even colleges tend to ignore depreciation to an extent. Our finances are judged on EBITDA, a technical definition that measures surplus before depreciation. At one level, this aids comparability (London college buildings have higher values than those in Cumbria for example) but can allow us to lose focus.
In the early years of incorporation, there was a period when the FE Funding Council allocated almost all its funds as revenue funding. The logic was that colleges could then determine the level of surplus needed to generate cash for maintaining or improving their asset base. Coupled with the freedoms to demolish, relocate and borrow, it meant colleges had real skin in the game when it came to investment and spending decisions. If bankers need repaying you are only going to spend where you are confident of a return, else you suffer the pain.
Reclassification and the modern approach mean government decides on the revenue/capital funding split. As capital grants move towards 100 per cent of costs (as with schools) the risk to a college from a speculative capital bid is pretty small. Inevitably this lack of jeopardy will mean capital misallocation and poorer returns.
Worse, those that miss out have to cope with watching their buildings become less useful and less safe. Just to put it in perspective, the combined finance record published for 2020-21 showed college depreciation is £503m each year. What is the likelihood that college capital will match that every year from now on, both in total and for each individual college?
The attraction for government for separate budgets for capital and revenue is obvious. Shiny new investment in schools and colleges wins publicity and votes, but vanity investment crowds out the dull routine investment that shows much higher returns. Government also likes to choose which investment to support, which prioritises bidding above education. Incorporation placed investment decisions firmly where they should be, in the hands of the institutions.
You could argue government ringfencing is sensible because schools and colleges are tempted to think short term, to spend on staff rather than buildings. But what we now have are public services that don’t think it is their moral obligation to maintain the taxpayer-funded assets they use. And the NHS shows that government is also prone to short term decisions. Perhaps if every investment made by government was followed by an annual bill to the users, it would force these real costs to be recognised and met.
The problem is acute and getting worse. The sector accounts for 2020-21 show we have land and buildings valued at £10.5 billion, compared to £10.8 billion in 2016-17. Land is rarely depreciated so this represents a sharp fall in building asset values. It implies we are investing only £85 for every £100 lost through depreciation.
Our current PM and opposition leader are less charismatic than their high-profile predecessors. Commentators argue this reflects a more serious, maybe boring approach to running the country. Depreciation is hardly a subject to set pulses racing, but maybe in these serious times, its serious message may finally be appreciated. For the sake of our students and our health, let’s hope so.
The views expressed in Think Further publications do not necessarily reflect those of AoC or NCFE.