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Private public partnership is an agreement between public and private sector entities on the financing and the provision of public infrastructure. The government contracts a private partner to finance, operate and build infrastructure assets for a certain period of time.
In the past, governments solely took up the role of operating and owning infrastructure facilities such as schools, roads, ports, bridges, water supply, and electricity supply and telecommunication networks (Colman, 2002). This was due to the fact that the private sector failed to earn revenue from infrastructure such as roads due to the difficulty in charging the public for its use (Moszoro, 2008). Governments also feared the emergence of monopolies in the provision of important services such as education and health.
Past technological developments have however made it possible for the private sector to benefit from infrastructure developments and provision of essential services. This coupled with the increased efficiency by the private sector in service delivery has led to an increase in private involvement in infrastructure development (Minnow, 2009).
Private public partnership involves the provision of infrastructure through a partnership existing between the public and private sectors. It is a contract between private and public parties where the private party agrees to bear the operational, financial and technical risks that accrue from providing public service (Harris, 1996). The cost of using this service might be borne by the one using of the service, the government or both according to contract terms. Oftenly, the government gives incentives such as tax subsidies to encourage investors to invest in infrastructure.
Through the formation of special purpose vehicles (SPV) by the private sector, the government contracts the SPV to build, develop, operate and maintain an asset for an agreed period of time. This is seen as a way to reduce government spending and increase efficiency in service delivery (Industry Commission, 1996). In most cases, the rate of return to the private party in private public partnerships was over the government's risk free lending rate (Onses, 2003). This has raised questions over the role of private public partnerships as vehicles of reducing public debt. Emphasis has however been on increase in value for money. Governments should give an extra amount if it means better services to the taxpayer.
A balance sheet or a statement of financial position is a statement which shows a companies assets, liabilities and net worth. It is used by investors, managers and external users to determine the financial position of the firm in relation to other companies. Firms having more assets than liabilities are observed to be in a good financial position.
Some elements of the balance sheet however do not appear on balance sheet. These elements are referred to as off-balance sheet entities. Off-balance sheet liabilities are liabilities which are not recorded on the balance sheet but require payment of an amount in future (Quiggin, 1996). This has adverse effects as the balance sheet will be used to make key financial decisions and would not reflect a true and fair view of a company’s financial position.
To fully appreciate the impact that that off-balance sheet would have, we briefly look at the accounting fraud at the Enron Corporation. Enron Corporation was an American commodities, services and energy company based in Houston, Texas. It was one of the worlds leading natural gas, communication and electricity companies with reported revenues of nearly $101 billion in 2000 before its bankruptcy in Dec2, 2001. Enron Corporation’s success was due to a manipulation of its accounts and large amounts in off-balance sheet liabilities (PwC Health Research Institute, 2010).
Private public partnership contract payments for operational costs and maintenance are considered to be revenue rather than capital spending. This is because of the supposed risk transfer to the private firm. Therefore the government's balance sheet does not show capital spending on these projects.
This has raised concerns over the circumvention of public finance processes which are aimed at ensuring transparency, accountability of financial expenditure and fiscal control. The lack of transparency leads to less scrutiny of the private public partnership due to the reduced exposure of investment performance to parliament and the community (Monbiot, 2000).
Measures have been taken to promote accountability and improve transparency in the private public partnerships. Some countries have made it a requirement to publicly avail statements of the liabilities that governments incur to try to solve the problem of off-balance sheet liabilities (Epstein, 2007). Some contracts are also being treated as finance leases rather than property leases so as to avoid off-balance sheet liabilities.
Traditionally, governments have borne the burden of developing infrastructure and providing services such as education and health. Private public partnerships have since been formed to help ease this burden. The involvement of the private sector in infrastructure development was seen as a solution to the increasing government debt that resulted from infrastructure development.
Public private partnership contract payments for operation costs and maintenance are considered to be revenue rather than capital spending. This is because of the supposed risk transfer to the private firm. Therefore, the government's balance sheet does not show capital spending on this project (Venkat, 2009). Off-balance sheet liabilities were also welcome as they helped to show a healthy government balance sheet which lowers government borrowing levels and support credit ratings.
It is generally accepted that accounting should not drive any transaction. Accounting should 'follow' a transaction to fairly present the economic substance of a transaction. Any accounting uncertainty may lead to the adverse effect of reducing commercial innovation by affecting long-term cost lifecycles and capital optimization. The lack of a generally accepted guideline might be the cause for the government's reluctance in the changing of the balance sheet treatments.
Inconsistency in the treatment of similar transactions over time can also lead to the loss of public confidence in the government. Suspicion may arise as to why the treatment of a transaction that has been accepted over time is suddenly changed. Tax payers might suspect corruption and collusion of the government with the private sector to steal from the public (House of Representatives Standing Committee on Communications Transport and Microeconomic Reform, 1997). Due to the sensitive nature of this issue, the government may decide to continue with the off-balance sheet treatment.
Governments may also be cautious to avoid lengthy and costly debates over appropriate accounting treatment of public private partnerships. This is a huge factor especially when the political environment is tense (Economic Planning Advisory Commission, 1995). Attempting to change off balance sheet treatment may lead to adverse political consequences such as politicians and high ranking government officials losing their seats.
Due to the adverse effects that off-balance sheet liabilities had on banks in during the recent financial crisis, governments have been more willing to include off-balance sheet liabilities in the balance sheet. By treating some private public relationships as finance leases other than operating leases, government balance sheets have been able to include off-balance sheet liabilities in the balance sheet (Williams, 2008). In situations where it is not able to represent them on the balance sheet, provisions may be made to include off-balance sheet liabilities separately.
In a bid to enhance transparency, accountability and efficiency in private public partnerships, governments have seen the need to disclose all the expenditure and liabilities it incurs. This improves the level of confidence that the public, potential investors and partners have in the government.
It also increases the government's credit worthiness making it easier for the government to borrow from financial and monetary institutions such as the IMF and World Bank. Lease accounting standards have been used to account for public partnerships. These standards, however, are unclear, inappropriate or inflexible (Daniels, 1980). To ensure transparency and flexibility in accounting, an alternative accounting standard should be used. Lease accounting standards often lead to off-balance sheet liabilities and changes to the accounting standards will increase transparency, clarity and full disclosure in the financial statements (Spackman, 2002).
Off-balance sheet liabilities often result in private public partnerships being more costly in terms of the public sector budgetary position as opposed to the conventional government means. The use of inappropriate standards may cause the expenses and liabilities to exceed due to unrecorded liabilities. Although the liabilities are not recorded, the government still has to bear extra costs incurred in the project (Möric, 2009). This might cause the private partners to have a higher rate of return, a rate which is above the government bond rate.