With ever-increasing competition amongst universities to provide the best proposition to students, we have seen continued investment in student accommodation projects across the UK infrastructure market since 2017. Whether these projects are new builds or renovations, ensuring that a university can provide quality student accommodation can require extensive financing and resources.
A university entering into a public-private partnership (PPP) for accommodation will sub-contract out the financing, construction and maintenance of accommodation to a private sector entity (typically a special purpose vehicle, or SPV). In exchange, it will receive an upfront cash lump sum, which can be re-invested by the university to further its educational objectives. However, the contractual arrangements may result in the assets and liabilities of the SPV being recognised in the university’s statement of financial position, i.e. being ‘on balance sheet’.
Universities will typically wish to avoid an on-balance sheet treatment. Therefore, it is essential for the parties involved to know the relevant factors that determine such an outcome.
In this blog, we look at:
- why universities do not want a student accommodation project to be on-balance sheet;
- what factors determine whether a student accommodation project is on- or off-balance sheet;
- the considerations private sector SPVs should give to these factors;
- the accounting implications on the financial statements of the private sector SPV; and
- future developments.
How are student accommodation projects typically structured?
University student accommodation projects usually involve creating an SPV (in which the university might take a shareholding) to build and operate the site over an agreed number of years. After this, the ownership of the student accommodation reverts to the university. While the university collects rents from the students, these rents (in most cases net of an admin charge) are subsequently payable to the SPV.
On balance or off-balance sheet?
A key theme for this type of project is whether the assets and liabilities of the SPV should be reflected in the university’s consolidated financial statements.
Why does it matter to universities?
Entities that a university controls are included in their consolidated financial statements and impact Key Performance Indicators (KPIs) such as EBITDA and gearing (i.e. their debt-to-equity ratio). Therefore, universities do not wish to distort their consolidated financial statements by including the assets and liabilities of the SPV, as this could impact its financial covenants and its ability to attract other finance. But what determines whether an entity is under the control of the university or not?
The definition of control in section 9.4 of FRS 102, which is also presumed by the further and higher education SORP, or Statement of Recommended Practice (SORP 2019), is:
“the power to govern the financial and operating policies of an entity so as to obtain benefits from its activities.”
The basic presumption of control is where a parent entity (i.e. the university) owns, directly or indirectly, more than 50% of the voting rights of an entity (i.e. the SPV). However, FRS 102 states that control can still exist in situations where a parent entity holds less than 50% of the voting power, as the parent may have effective control by virtue of other powers granted to it. For example, a university may only have a minority 5% shareholding in the SPV, but control would still exist should the university have the power to govern the financial and operating policies of the SPV via a separate agreement.
What are the implications of this?
Control under FRS 102 extends beyond simply owning more than 50% of the voting power. In practice, the SPV and university must consider any rights attached to the university’s shareholding interest (if any) and any powers (either explicit or implicit) inherent in the contractual arrangements between the university and the SPV. In projects we have seen, universities typically hold a 0-19% shareholding with no special rights over other shareholders. However, further factors need to be considered.
Further factors: Control over a special purpose entity (SPE)
An SPV established for a student accommodation project will likely be viewed as an ‘SPE’ under FRS 102, as the SPV will be created “to accomplish a narrow objective”. Consequently, FRS 102 widens the definition of control by including additional subjective factors.
For example, one factor a university must consider is whether it is entitled to the majority of the benefits of the SPV while being exposed to the majority of the risks. We often see universities include “nomination agreements” whereby the university guarantees the SPV a minimum amount of rental income for a certain number of years. Such guarantees result in some of the risks and rewards of ownership of the SPV being passed from the SPV onto the university during such periods.
However, control should be determined considering all of the factors stated in FRS 102, rather than focusing on one element in isolation.
What are the implications of this?
Contractual conditions and clauses should be carefully reviewed to assess whether the majority of risks and rewards are being transferred from the SPV to the university throughout the life of the student accommodation project. If that is the case, the contract must be changed to keep the SPV off-balance sheet from a university’s point of view.
Accounting considerations for the SPV
In a typical university accommodation project, the SPV will recognise assets on its balance sheet. However, the type of asset recognised on the SPV’s balance sheet depends on its contract with the university.
Where the contract with the university constitutes a ‘service concession arrangement’, as defined under Section 34 FRS 102, the SPV will recognise a financial asset, an intangible asset or both (i.e. a bifurcated approach) depending on the specific conditions within the contract. Alternatively, if the contract does not constitute a service concession arrangement, a fixed asset will be recognised on the balance sheet.
We usually find the conditions of Section 34 are met such that an intangible asset is recognised to reflect the SPV’s ‘right to charge’ students for income. However, where there are nomination agreements in place, it might be appropriate to recognise a financial asset in respect of the ‘guaranteed’ income the SPV is due to receive from the university, in addition to an intangible asset being modelled.
What are the implications of this?
The accounting treatment adopted can significantly impact the profit profile of the SPV over the life of the project. For example, the accounting treatment of finance fees and the requirement to recognise a lifecycle provision differs depending on the accounting treatment adopted. Therefore, it is crucial to recognise the appropriate type of asset(s) from the outset of the project to ensure the accounting position and, in turn, the tax position of the SPV is fairly stated.
The Financial Reporting Council (FRC) is currently undertaking its next periodic review of FRS 102, with an effective date expected to be on or after 1 January 2024. Critical matters for debate include whether FRS 102 should bring virtually all lease arrangements onto the balance sheet (and therefore in line with IFRS 16) and whether revenue should be recognised and measured more in line with IFRS 15.
Given SORP 2019 was issued following the last triennial review of FRS 102 in 2017, we might expect the SORP to be updated following the current review of the FRC. Therefore, Universities will have to consider the implications of any changes made to the accounting rules and the interaction between changes in FRS 102 and the SORP.
Structuring student accommodation projects to be off-balance is fundamental to universities. Determining whether a university controls an SPV requires more in-depth analysis than simply its direct/indirect shareholding. Consequently, it will be for the SPV to work with the university to tailor and prepare the contractual arrangements so that the SPV has sufficient independence from the university and thus is not adjudged to be under the control of the university.
Operis has advised both universities and SPVs on the accounting implications of student accommodation projects. We can review the contractual arrangements to ensure that they will not result in an on-balance sheet treatment for the university.
If you have any questions regarding the above or would like to speak to someone at Operis about potential accounting issues relating to university accommodation projects, please do not hesitate to get in touch.