Contractual obligations are a 21st century style of debt but the slow-to-adapt accounting profession has trouble agreeing how these should be reported. In the absence of stronger direction, these are typically announced in technical footnotes to annual financial statements.
Most obligations arise from public-private partnerships (P3). Using the model, if it wanted a bridge across a river, government would pay a private partner to build and maintain the crossing in return for regular payments over the life of the asset. The obligation to the P3 provider would not be reported as debt.
Traditionally, for a river crossing, government would borrow money, hire contractors for construction and have the highways ministry arrange for maintenance. Debt incurred to build the bridge would be reported on government balance sheets, included in debt/GDP calculations and retired by payments to the lender.
Retired economist Erik Andersen presented a paper about contractual obligations to the legislative budget committee 2 years running and was met with stony silence from all MLA committee members.
Some are simply disinterested, others see this as a way for them to pretend that public debt is less than it is.
Mr. Andersen has turned attention to the professional body that make rules for accountants in Canada. This is a letter he sent to them:
Chartered Professional Accountants of Canada
277 Wellington St. West, Toronto, Ontario
For several years, the attempts by me and others to draw politicians into an examination of “contractual obligations”, have failed spectacularly. Their lead in this matter is from accountants who keep the definition of debt very narrow. By report dated February 2017 the BC Auditor General presented “The 2015/16 Public Accounts and Auditor General Findings”(1). Starting on page 37 this report gives a presentation on “Contractual Obligations”. The important words from this report, that all politicians use as their “fig leaf”, are that these obligations are not debt.
Correct me if I am wrong but would what those accountants in the USA use as a definition of the “purpose of accounting” would likely apply in Canada? The AAA states; “Accounting is the process of identifying, measuring and communicating economic information to permit informed judgment and decision by users of the information. “
These “debt” and “contractual obligations” definitions are used variously depending what is the needed purpose. On page 11 of the BC Comptroller’s report of the same year, it shows the reader the ratio of “Taxpayer-supported debt to GDP” (2). This ratio is an indicator of how indebted the province is compared to its income, measured as GDP. The lower the ratio the higher the quality of the Province’s credit rating; the closer the ratio gets to one the greater the worry of insolvency “Greek style”. This makes it clear that it is a great optic to maximize the use of “Contractual Obligations” to suppress this ratio. In reality, by signing supply contracts the Government it getting a third party to do the borrowing but not escaping the liability.
This one-dimensional definition of a “Contractual Obligation” is not the whole story. Early in this century BC Hydro was ready to sign a contract for electricity from an Independent Power Producer (IPP), to be located at Duke Point on Vancouver Island. This contract provided for a minimum cash payment of $25 million for the term of the contract and was the minimum guaranteed by BC Hydro/Province even if no electricity was ever produced and delivered. This was an example of a financial obligation that was not driven by the production of electricity; it was driven only by the calendar. In that respect it was like a “Bond”, if not exactly like debt. In this case the present value of the guarantee was $500 million while the cost to build according to the IPP was to be $300 million. Those of us who were opposing this project sought and got the right to bring this proposal into a real court of law, upon which the IPP and BC Hydro disappeared. After this episode the Premiere made all IPP contracts secret.
Thinking as a lender/financing party for all IPPs and “Public, Private Partnerships”, the investments to be made are for fixed in place assets. Because they carry a risk of becoming “stranded assets” the financings must be designed to provide certainty of repayment of loans, even if by a third party contractor. If the public were able to read these contracts then we would know the financial obligations each requires even if not able to deliver any goods or services.
I think the cash guarantees are debt and that is why I am writing today to secure your support for an accounting change in the reporting of these “Contractual Obligations”. To have $100 billion of “Contractual Obligations” relegated to a footnote in the annual report of the Provinces finances, is not only a deliberate strategy to suppress the public’s awareness of their Government’s finances but an insult.
Erik Andersen, Economist