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Cabinet Office Circulars

Appendix to CO (99) 7


FINANCIAL DELEGATIONS FOR THE PURCHASE, DEVELOPMENT, OR LEASE OF DEPARTMENTAL FIXED ASSETS

Introduction

  1. This Appendix should be read in conjunction with CO (99) 7 and the attached Schedule. It provides guidance for departments on:

    • interpreting the delegation limits set by Cabinet for the purchase, development, or lease of departmental fixed assets; and
    • the information that should be provided when seeking authorisation from the Responsible Minister or Cabinet for proposals that would involve financial commitments above these delegation limits.


Financial Delegation Limits for Fixed Assets

  1. The financial delegation limits that Cabinet has approved for the purchase, development, or lease of departmental fixed assets are set out in the schedule attached to CO(99)7. The main limits are now $7 million for departmental chief executives, and $15 million for Responsible Ministers.

  2. Where a department proposes to expend cash, or incur expenses or liabilities, in excess of these delegation limits to:

    • purchase or develop fixed assets; or
    • lease fixed assets for more than one year;


    the department must obtain explicit financial authority from the Responsible Minister or Cabinet, as required, before entering into any financial commitments.

Approval "In Principle"
  1. If no firm estimate of costs can be made for a major, or long-term, fixed asset project without more detailed investigation of the proposal, a departmental chief executive may seek approval in principle to proceed on the basis of a provisional assessment of the likely financial implications.

  2. Approval in principle provides comfort that further, and potentially costly, investigation of the proposal is worthwhile, but does not provide the final authority for expenditure on fixed assets. It must be followed by specific authorisation of the whole (or remaining portion) of the work, as soon as firm, up-to-date cost estimates are available. Approvals in principle will be granted only in exceptional situations at the discretion of the Responsible Minister or Cabinet.

The Purchase or Development of Fixed Assets


Interpreting the Delegation Policy

  1. Departmental chief executives must ensure that the delegated authority they have, or the financial authority they seek, covers all costs (including GST where applicable) for all stages and components of a fixed asset proposal. For the purchase or development of fixed assets, this should include the dollar value of all sub-contracts and directly associated fixed asset purchases that are required to bring the proposed asset into operational use.

  2. Costs should be calculated using the best and most up-to-date estimates available. Asset development projects, where elements of cost uncertainty will often exist, might involve estimating the probability distribution of total costs using statistical techniques, in which case financial authority should be sought for the "expected value" of the estimated cost distribution.

Expectations of Applications for Financial Authority

  1. All applications for financial authority for the purchase or development of fixed assets should include a full description of the work to be done or asset to be purchased, in addition to a total (and breakdown where relevant) for all the proposed capital costs and cost components.

  2. To assist the Responsible Minister or Cabinet to reach an informed decision on the proposal, the application should be supported by the department's strategic business plan and a detailed business case. The business case should, among other things, include the following additional financial information:

    • expected maintenance costs and other operating expenses associated with use of the asset over its expected life.
    • the present value7 of the capital and operating costs over the life of the asset;
    • the range and distribution of potential costs for an asset development project, and the main assumptions or judgements supporting this distribution;
    • any contingent liabilities or risks arising from approval of the particular proposal;
    • the present value of all quantifiable benefits to the Crown arising from the investment.

Operating Leases for Fixed Assets


Interpreting the Delegation Policy

  1. The financial delegations policy has been extended to impose a delegation limit on operating leases for fixed assets (if the assets are to be leased for more than a year), in addition to the purchase or development of fixed assets. Accommodation leases and information technology leases are likely to be some of the larger operating leases held by departments. This policy change recognises that an operating lease is just another way to acquire the future use of a fixed asset, and can represent a substantial financial commitment for a department over the term of the lease.

  2. The delegation limits do not apply to operating leases where assets are being leased for a year or less, or to contracts for the provision of a service that includes the use of fixed assets.

  3. Finance leases, as distinct from operating leases, are not covered by this delegation policy. Treasury Instructions do not allow departments to enter into finance leases in their own right. A finance lease is considered to be a form of borrowing, and the Public Finance Act 1989 does not permit departments to borrow. The limited circumstances under which departments can enter into finance leases, and the information sought by the Crown for evaluating finance leases, are set out in Treasury Circular 1994/7.

  4. Departmental chief executives must ensure that the delegated authority they have, or the financial authority they seek, covers the value of all projected "minimum lease payments"8 (including GST, where applicable) over the full term of the lease. If a department proposes to lease a number of fixed assets that will operate as integrated components, then the financial authority should cover the lease payments for all such components. Given the evolving nature of operating leases, determining the value of minimum lease payments in any particular situation could involve some subjective judgements. Departments are therefore encouraged to discuss these judgements with their auditors, or their Treasury Vote analyst, to minimise any problems.

  5. Some operating leases cover only a short part of the life of the fixed asset but provide a right for renewal of the lease over part or all of the remaining life of the asset. For the purposes of obtaining financial authority, departmental chief executives may choose to value the lease payments only over the initial lease term, or value it over a period that also includes the renewal term or terms. However, for the purposes of this delegation policy, any renewal of an existing lease under a right of renewal clause will be treated as a variation to the existing financial authority, and not as a new lease.

  6. Other operating leases might not relate to a particular fixed asset but allow for the lease of a category of fixed asset that can be changed, varied or upgraded over the term of the lease. Again, for the purposes of this delegation policy, any changes to the asset are to be treated as variations to the lease and not as a new lease.

Expectations of Applications for Financial Authority

  1. All applications for financial authority for the operating lease of fixed assets should include a full description of the assets to be leased, the nature and term of the proposed lease or leases, and the value of the minimum lease payments for all relevant assets over the full lease term.

  2. To assist the Responsible Minister or Cabinet to reach an informed decision on the proposal, the application should be supported by the department's strategic business plan and a detailed business case. The business case should, among other things, include the following additional financial information:

    • all expenses and other financial commitments or obligations that the department expects to incur9 in order to use the leased asset over the full lease term.
    • the present value10 of the minimum lease payments and other costs the department expects to incur over the lease term;
    • the cost of any penalties associated with early termination of the lease, and any other contingent liabilities or risks associated with the proposed lease;
    • the fair value of the lease - the value at which the leased asset could be exchanged between a knowledgeable willing buyer and a knowledgeable willing seller in an arm's length transaction11. In practice, estimates are likely to be readily available from market information on the cost of a similar asset. This cost should be adjusted for the asset's residual value, where the lease covers a period significantly different from the life of the fixed asset; and
    • the present value of all quantifiable benefits to the Crown arising from the lease.

Variations to Delegated Financial Authorities


Interpreting the Delegation Policy

  1. Departmental chief executives or Responsible Ministers may approve variations to the original approved cost of a departmental fixed asset project (purchase, development or lease). The financial limits to the delegated authority of departmental chief executives and Responsible Ministers to approve variations apply in the following manner:

    • Where a departmental chief executive gives the initial approval for a fixed asset project, the chief executive may approve subsequent variations up to a total project cost of $7 million.
    • Where a departmental chief executive or a Responsible Minister gives the initial approval for a fixed asset project, the Responsible Minister may approve subsequent variations up to a total project cost of $15 million.
    • Where a Responsible Minister has given the initial approval (for a project costing less than $15 million), the relevant departmental chief executive may approve additional costs of up to 10% of the amount initially approved by the Minister, provided that the total cost of the project does not exceed the Minister's delegated limit of $15 million.
    • Where a fixed asset project not initially approved by Cabinet is re-estimated to have a total cost in excess of the $15 million limit, an application for authority for the new total should be forwarded to Cabinet.
    • Where Cabinet has given the initial approval (all projects over $15 million), the Responsible Minister may approve additional costs of up to the lower of 10% of the amount of the initially approved by Cabinet or $7 million. Any increase in excess of 10% of the initial approval or $7 million (whichever is lower) must go back to Cabinet for approval.

  2. An authority granted to a departmental chief executive or Responsible Minister is a total delegation limit that covers original approvals and variations. The new authority must be for the revised total, not just the amount of the increase. Further, the limits placed on financial delegations cannot be added together. The limit for Responsible Ministers is $15 million. It cannot be increased to $22 million by the addition of the limit for departmental chief executives.

  3. The 10% variation allowance provided for in this circular recognises there is uncertainty in practice around the cost of fixed assets, particularly projects for the development of fixed assets. This is a default allowance and, depending on the particular fixed asset project, Cabinet can always choose to amend it or cancel it. Ministers do not have the authority to amend the 10% variation allowance, except by special direction of Cabinet.

  4. The revised cost of a proposal should be calculated using the best and most up-to-date estimates available.

Expectations of Applications for Financial Authority

  1. All applications for variations to an existing financial authority are to include:

    • a summary showing brief details (amount, date, and authorising party) of the initial authority and each subsequent variation to that authority;
    • the revised estimate of total cash to be expended, or expenses and liabilities to be incurred, for which a revised authority is being sought; and
    • a full explanation of the reasons for the increase in the estimated costs and/or change in the scope of the proposal for the purchase, development or lease of fixed assets.

  2. All applications for variations to an existing financial authority should be supported by a fully revised and updated business case.

Example
  1. A department proposes a project for the development of a fixed asset with a total project cost estimated to fall in the likely range of $12m to $16m. The expected value of the estimated probability distribution of project costs is $14.5m.

    The expected value of the project is less than $15 million, so the Responsible Minister can grant financial authority for the project and project cost.

  2. The department later proposes a change to the scope of the project because an add-on module originally proposed is no longer required. The expected value of the project is now $14m.

    The expected value of the project is below the limit of the initial financial authority of $14.5m, but a revised financial authority is still required because the scope of the project has changed. The expected value of the project is still less than $15m so the Responsible Minister can grant a revised financial authority for the altered project and project cost.

  3. The department identifies that the cost of the total project is now expected to be $1.3m higher than previously estimated.

    The change in expected cost of the project is within 10% of the initial financial authority granted by the Responsible Minister, and hence might be able to be approved by the departmental chief executive. However, the total project cost at $15.3m is now higher than the financial authority limit of $15m delegated by Cabinet to the Responsible Minister. Hence the department must seek a revised financial authority for $15.3m from Cabinet.

 

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7 A discount rate equal to the relevant government stock rate may be used if no suitably robust project specific rate is available.
8 The term "minimum lease payments" is defined in generally accepted accounting practice (in the accounting standard on leases, interpreted in conjunction with the Statement of Concepts).
9 This could include the costs of equipment, software, leasehold improvements, contractor services, supplies, maintenance costs (especially where there are maintenence contracts in parallel with the lease), staff remuneration and related costs, and inter/intra agency payments.
10 A discount rate equal to the relevant government stock rate may be used if no suitably robust project specific rate is available.
11 This information is to assist in evaluating the lease or buy decision.

 

CO(99)7
Schedule