Blinkered by the books

Lease-back schools are the product of short-sighted budgetary tunnel vision. This becomes crystal clear when the long-term costs and risks of the schools are added up. Yet in a climate where keeping books in the black are government priorities, the former Nova Scotia Liberal government used the P3 model to get new schools with no apparent up front cost. Manipulating accounting rules to suit their political ends, they crafted leases to ensure the costs come out of the operating budget, paid out over twenty years, rather than up front.

Nova Scotia’s Auditor General is concerned the government has backed itself into a corner when it comes to lease-back schools. Auditor General Roy Salmon says the province is "using a narrow definition of debt…There is still a commitment to make lease payments for 20 years, and that is the next thing to a debt." He criticized the government’s rush into P3s, saying "accounting treatment should not drive decision-making."

When is a lease not a lease?

For governments caught up in a debt-hiding exercise, this question is crucial. Whether the lease for a P3 school is classed as a capital lease or an operating lease determines which partner benefits and which assumes the risks ã and how the expenses appear on the province¼s books.

Capital leases are accounted for in the same way as a capital expense, meaning the cost appears on the books all at once. Under a capital lease, the public sector assumes more of the risks and benefits of ownership, and the board or province either owns the school at the end of the lease or can buy it at below market value. Accounting rules dictate that lease payments must cover most of the value of the property (90 per cent) for the lease to qualify as a capital lease.

Operating leases are the government¼s preferred option, as costs are reported as the lease payments take place, not as a lump sum. This allows the government to essentially hide a debt it is still responsible for. Under operating leases, the corporation is supposed to take on the risks and benefits of ownership.

Corporations tend to favour capital leases because of a financial incentive called the Capital Cost Allowance. The CCA gives corporations a hefty tax break, allowing capital assets to be depreciated for tax purposes at a faster rate than that allowed by standard corporate accounting.

While the Nova Scotia government attempts to negotiate operating leases, in at least one instance it was forced to renegotiate a signed lease after Auditor General Roy Salmon ruled the O¼Connell Drive school deal did not meet the definition of an operating lease and so would appear on the province¼s bottom line. The lease, the first P3 school lease to be signed, was hastily renegotiated with an extra $50,000 being spent on construction of a fence to meet the operating lease accounting test.

While Salmon said the lease then passed the mathematical test, he was critical of the process, saying that accounting needs were "driving other issues." Responding to questions about why the lease lacked a clause requiring the consortium to upgrade technology over the life of the 20-year lease, Salmon said "one would conclude the province was in a very poor negotiating position and the consortium was in a very good position, because the school had already been built before the lease was signed."