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Policy Exchange’s accounting errors

October 19, 2015

Wonkhe has corrected a comment piece that appeared earlier today on its site that originally confused surpluses and reserves.

The comment piece was there to promote a new report from Policy Exchange calling for resources to be diverted from English HE to FE. Their case hinges on the level of reserves seen on average across the university sector.

Unfortunately Policy Exchange are just fundamentally confused about accounting.

The question to ask, therefore, is not “would cuts be harmful”, but “where would cuts be least harmful in the context in which we find ourselves”. The answer is that when looking at the post 19 education and training system as a coherent whole, the HE element is significantly better funded than its FE counterpart, has substantial cash reserves which could be better utilised than sitting in banks, and has made insufficient progress on efficiency savings to date when set against either FE or any other public service. This then is the case for a reallocation of resources away from HE to protect FE.
Higher, Further, Faster, More p.11

The evidence used to back this claim comes from Hefce’s most recent annual report on the Financial Health of the sector. Policy Exchange cite a figure of 48% for reserves.

55. Discretionary reserves at the end of 2013-14 totalled £12,292 million, after taking into account the impact of the financial reporting standard on retirement benefits (FRS17). This reporting standard, which requires pension scheme surpluses or deficits to be included in the balance sheet (but not yet those of multi-employer schemes such as the Universities Superannuation Scheme (USS)), makes comparisons with previous years more difficult. Without FRS17, reserves totalled £16,472 million, equivalent to 64.4 per cent of total income.
56. Total reported pension scheme deficits (excluding those relating to multi-employer schemes) increased by £678 million to £4,180 million in 2013-14, reducing reserves to 48.0 per cent of income.

The full Policy Exchange report includes this Figure from Hefce’s report.

click to enlarge

discretionary reserves

Unfortunately, as a Hefce footnote makes clear: ‘discretionary reserves’ are not ‘cash reserves’.

Discretionary reserves are equal to expendable endowments plus general reserves from the balance sheet.

And general reserves is a measure achieved by comparing all assets – not just cash, but also properties for example –  to all liabilities. It isn’t cash reserves either (cash would normally be classed under ‘current assets’)!

JNCHES’s guide to university financial reports (a recommended read!) puts it this way:

[Look at] your assets and liabilities at the end of the financial year – the difference is called your ‘equity’ and will be referred to in accounts as your Reserves.
Think of it like a private house. Usually, the outstanding mortgage will be less than the value of the house, so you’ll have a positive equity. It can be the other way round and that can be a serious problem for an individual or an institution. For substantial organisations like HEIs, balance sheets need to accommodate a variety of transactions with rather technical labels, but the essence of the statement remains – assets less liabilities equals reserves. …

However big your reserves are, they’re not the same as cash. To convert reserves into cash, you’ll have to sell assets. Don’t assume those assets will sell for the amount showing on the balance sheet.

Others have complained about the misrepresentation of these HE statistics.

But they’ve missed the fundamental error made by Policy Exchange – they mistook reserves for cash!

And in doing so, peddled some dangerous nonsense.

  1. Jonathan Simons permalink

    Thanks for this Andrew. One admission, and then a rebuttal. You’re right that we shouldn’t have described the £12bn as cash in be sentence you highlight – they are indeed, as HEFCE call them, discretionary reserves – as we indeed also call them later in the report. And the argument is built on that basis. Because although they aren’t cash, they are *cashable*. That’s exactly our argument and indeed the point made in the link you cite above – it’s a legitimate strategy in certain instances to draw on cashable reserves, particularly if financial circumstances are tight and / or you have significant cashable reserves. That’s exactly our argument as to what universities should do.

    I’m running around for a lot of today but I will try to do a fuller response to this on wonkhe (also addressing UUKs argument around operating surpluses)


    • Thank you for responding Jonathan.

      Every reference to ‘reserves’ in your report implies ‘cash’. For example,
      “Importantly, any remaining grant should be reallocated on a tapered basis, so that any residual HEFCE funding in this area be used to offset differential reserves, so that universities with smallest reserves are given the largest funding. This would indeed, deliberately, act an incentive not to hold reserves over a
      certain limit.” (p.10)
      Or: “Even after accounting for pension liabilities and the deficit within the universities pension scheme, operational reserves for the sector stand at £12.3 billion, or 48% of the entire annual operating income of the university sector.” (p.30)

      What you seem to be suggesting now is that universities should cover a cut in funding( and potential operational deficits) by selling property.

      That’s a different argument to the one in your report, which argues that universities are awash with cash so can take cuts to funding.

      • Jonathan Simons permalink

        I’m not sure either of those two examples you cite do imply cash – they both speak specifically of reserves being held which can be used to offset a funding cut. My argument is and has always been just that – that between the reserves held by the sector and further scope for efficiency gains they’re well capable of absorbing a funding cut – and that we should compensate those least able by tilting any remaining grant to them.

        For some universities, whose reserves are not cash but are instead in things like property, and have no scope for further cashable savings elsewhere (which I would have thought unlikely at the scale of reallocation I’m proposing but theoretically possible), yes I wouldn’t have an issue with them selling or in some other way monetising that property asset, just as other autonomous institutions that receive public funding like NHS Foundation Trusts have done in some instances (and indeed FE colleges have done, and some universities are already doing, for example OU in the news today). It’s obviously up to the university to make the decision how they cover their costs. My argument is that the HEFCE data shows they have plenty of reserves with which to do so.

  2. I think it’s clear that ‘operational reserves’, however unusual a term, implies cash and that the idea of defining an acceptable ‘level’ of reserves does so as well.

    It’s perfectly common for reserves to imply ‘cash reserves’ – it’s that the only figures cited in your report for the level of reserves is for ‘general reserves + expendable endowments’, which is quite different from cash.

    Selling assets to fund operational deficits is not a sustainable funding solution. Universities do sell property but largely to fund new capital expenditure, investment or redevelopment plans. They really shouldn’t be doing it to cover funding cuts. The Open University isn’t a healthy counterexample here.

    The sector average shows large general reserves because there is a substantial part of the sector that is historic and has acquired and developed buildings over time.

    What you need to do is justify your line is identify spare estate capacity that can be sold.

    • Jonathan Simons permalink

      I’m not sure that I agree (perhaps unsurprisingly!)

      There’s £12bn of reserves that have been identified as sitting on balance sheets as discretionary; a mixture of cash and other assets that are both cashable and by virtue of being discretionary, not identified for another fixed purpose (or at least not in such a way that they can’e be reallocated, these aren’t restricted funds),

      Of course, in the longer term, selling off fixed assets or using lump sum funding to pay ongoing revenue costs isn’t sustainable. But – and there’s two big buts – for that to be our proposed solution implies two things, neither of which are true:

      1) there aren’t significant potential other efficiencies which could be made to move to a lower order of running costs in steady state. We talk in the report about how on average the university sector has made 1.5% efficiencies in the past three years of recorded data. That’s pretty low, compared to many if not all other areas of the public sector. I find it deeply implausible that there isn’t significant scope for changing this (and indeed, it’s very common for government to demand efficiencies and give a lower grant without any recognition that there a way of delivering that; whereas we have specifically identified room for further efficiencies by virtue of using that 1.5% as a starting point)

      2) that in the short term, whilst moving to a more efficient operating model, that any form of selling off of assets or using other reserves isn’t a legitimate and recognisable financial strategy. It absolutely is – I was previously a trustee of a small charity and for a number of years we used up elements of our reserves whilst either investigating whether we could increase revenues or decrease costs. Indeed, the very JNCHES guide you cite says ” If you have substantial equity, you can live on your wealth for a time. It may not be a very good idea, because you’re using up the family silver, but it can give you breathing space”.

      That’s exactly what we’re advocating – using reserves to manage short term additional costs brought about by a reduction of grant, whilst the efficiency process accelerates to move to a more steady state solution (and / or an increase in income from elsewhere presents itself, which is of course possible but outside the scope of our report).

      I don’t think it would be realistic – nor, in truth sensible – for PX to have gone around saying “right well University X should sell asset A and B, university Y have buildings C and D they could do this with” and so on. That’s a level of micromanagement far in excess of what is reasonable. The right approach is to say, as we have done – universities are comparatively very wealthy here, they have significant reserves, these should be utilised in the way they choose to manage a reduction in grant in order that another sector be financially supported, and any remaining grant should be allocated to those with the smallest reserves

  3. Mike Picken permalink

    1) Policy Exchange proposes to remove £532M from the HEFCE budget, to be reallocated to Adult Skills. Of this the majority, £380M, is the HEFCE Student Opportunity Fund allocation for Widening Participation. But nearly 11% of the £364M allocation in 2015-16 already goes directly to FE Colleges delivering HE provision anyway (£38M – top 10 listed below). In addition, an unknown but not insignificant proportion of the SOF allocation for HEIs will also be returned to those FE Colleges who are in an indirect funded reltationship (sub-contracted or ‘franchise’ provision) with an HEI for their HE provision. This seems more like ‘robbing Paul to pay Paul’ (see page 11)!

    2) Do we have any feel for what the effect of the Policy Exchange proposals and particularly the proposal for a ‘tapered’ reallocation (page 10) would be on different types of institutions? The Student Opportunity Fund is selective and goes disproportionally in terms of the totality of Teaching funds to those institutions with a higher number of students from widening participation backgrounds, mainly post-92 institutions (and FE Colleges). The top 20 HEI allocations are below. If those HEIs are not the institutions that have higher ‘reserves’ (however calculated), then removing the funding doesn’t deliver the policy objectives that Policy Exchange claim to be seeking. It might be better argued that transferring the allocations for QR Research funding for eg Theology and for eg Classical studies to the Adult Skills budget, would have less impact on economic recovery and a more policy-driven effect; 31% of that funding goes to the Universities of Oxford and Cambridge who are wealthy and well-endowed, maybe they could more easily afford to make up the shortfall than those listed below? This would certainly guarantee Policy Exchange more headlines as being ‘philistines’ and ‘nonsensical’, but is actually more rational than what they have proposed (As a society, do we really believe that an increased understanding of Theology will deliver better opportunities for an economic recovery than encouraging poorer people to improve their education?).

    3) The ‘dangerous nonsense’ from PE that this whole thing reveals is that they (PE) have laid the groundwork for that Student Opportunity Fund being cut by BIS anyway, on the specious grounds that HE institutions are awash with funds and do not ‘need’ the monies. The ‘big idea’ from PE is that BIS will cut it and then transfer the money to the Adult Skills funding allocation. Instead, BIS are more likely just to cut the money anyway and use it to deliver the Treasury savings that will be unveiled in the austerity-led public spending review due on November 25th. Thus, PE will have done the government’s dirty work in laying the grounds for cuts that will actually reduce economic investment and in social barriers to advanced education, the very opposite of the ‘policy’ they intended.

    Top 20 Student Opportunity Fund HEI allocations 2015-16 (£)
    1 The Open University 34,370,893
    2 Manchester Metropolitan University 8,154,384
    3 University of Central Lancashire 7,038,323
    4 Sheffield Hallam University 6,664,077
    5 The University of Wolverhampton 6,547,532
    6 University of Plymouth 6,270,058
    7 Staffordshire University 6,196,251
    8 Leeds Beckett University 6,122,496
    9 Nottingham Trent University 6,075,245
    10 Liverpool John Moores University 5,851,911
    11 Teesside University 5,791,148
    12 Anglia Ruskin University 5,677,283
    13 Coventry University 5,536,648
    14 Kingston University 5,263,975
    15 Birmingham City University 5,190,505
    16 University of Derby 5,093,566
    17 De Montfort University 5,063,815
    18 The University of Huddersfield 5,046,898
    19 University of Greenwich 5,022,310
    20 University of Portsmouth 4,946,056

    Top 10 Student Opportunity Fund FEC allocations 2015-16 (£)
    1 Blackpool and the Fylde College 1,836,092
    2 NCG 1,592,228
    3 Bradford College 1,187,712
    4 Blackburn College 1,107,540
    5 Heart of Worcestershire College 1,007,731
    6 Grimsby Institute of Further and Higher Education 1,007,509
    7 The Manchester College 950,261
    8 New College Durham 718,779
    9 Leeds City College 718,018
    10 Hull College 702,091

  4. Mike Picken permalink

    Sorry a word dropped off my post. In para 2) middle sentence I meant to say

    ‘would have less impact on economic recovery’

    ie that chopping the QR Research funding for Theology, Classics etc would not be as bad for the economy as cutting Student Opportunity Funding elsewhere.

    Just for comparison purposes, the QR allocation to the University of Oxford for Classics research in 2015-16 was £1.56M, significantly more than eg Blackburn College in Lancashire gets for Student Opportunity Funding for its 1,000+ HND/Foundation degree/honours degree students from poorer backgrounds (and mostly in vocational/technical subjects by the way). Which is not to say that it should be an “either/or”, but it does raise the question of why this particular target for cuts has been chosen by the Policy Exchange in preference to other choices that maybe have more people in higher echelons of society to defend them? HEFCE annually spend nearly as much on research into Theology and Classics as they do on research into Social Work and Social Policy, by the way… if it’s a question of priorities for public investment, one has to ask which one has a better chance of helping to solve our society’s problems? … I’m not deliberately inviting accusations of being a philistine here, just playing ‘devil’s advocate’ to a report that asks us to make choices!

  5. Mike Picken permalink

    Curses! WordPress deleted the word ‘deleterious’ between ‘less’ and ‘impact’

    … I hate these sites that don’t allow you to preview or edit a post after you’ve submitted it and seen what it looks like! Apologies, Andrew!

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