Notes to the Accounts

1. Statement of Accounting Policies

Introduction

1.1 These financial statements have been prepared in accordance with the Accounts Direction issued by HM Treasury dated 25 February 2003 and comply with the requirements of HM Treasury’s Resource Accounting Manual (RAM). In order to reflect the particular circumstances of the Department, the following exceptions to the RAM have been made:

• The Operating Cost Statement is not segmented into programme and non-programme expenditure, as agreed with HM Treasury.

• Separate statements are not prepared for non-agency parts of the Department, as agreed with HM Treasury.

• The Department’s fixed assets are not analysed using the categories set out in the RAM. The different categorisation of the fixed assets became effective from the year 2002-03, but dispensation from this new requirement has been granted by HM Treasury until 2004-05.

Accounting Convention

1.2 These financial statements are prepared on an accruals basis under the historical cost convention, modified to include the revaluation of certain fixed assets and stocks.

Basis of preparation of Departmental Resource Accounts

1.3 These financial statements comprise the consolidation of the Department, its Defence Agencies and those Advisory NDPBs sponsored by the Department which are not self-accounting. The Defence Agencies and the Advisory NDPBs sponsored by the Department are listed in Note 31.

1.4 Five of the Department’s agencies are established as Trading Funds. They therefore fall outside Voted Supply and are subject to a different control framework. Consequently, the Department’s interests in the Trading Funds are included in the financial statements as fixed asset investments. Executive NDPBs operate on a selfaccounting basis and are not included in the consolidated accounts. They receive grant-in-aid funding from the Department which is treated as an expense in the Operating Cost Statement.

1.5 The Department’s interest in QinetiQ, a Self-Financing Public Corporation, is included in the financial statements as a fixed asset investment. At 31 March 2002, the interest was in QinetiQ Group plc.

1.6 The AFPS is not consolidated within these financial statements. Separate accounts are prepared by the AFPS.

1.7 Machinery of Government changes which involve the merger of two or more Departments into one new Department, or the transfer of functions or responsibility of one part of the public service sector to another, are accounted for using merger accounting in accordance with the Financial Reporting Standards (FRS) 6.

Net Operating Costs

1.8 Costs are charged to the Operating Cost Statement in the period in which they are incurred and matched to any related income. Costs of VAT recoverable Contracted-Out Services are included net of related VAT. Other costs are VAT inclusive, although a proportion of this VAT is recovered via a formula agreed with HM Customs and Excise. Surpluses and deficits on disposal of fixed assets and stock are included within Other Operating Costs (Note 3).

1.9 Income from services provided to third parties is included in operating income, net of related VAT. Dividends are included in the operating income in the year in which the cash is received.

Fixed Assets

1.10 Through the application of the Modified Historical Cost Accounting Convention (MHCA), the Department’s fixed assets are expressed at their value to the Department on an inflation-adjusted basis, i.e. at actual or estimated current values. The Department achieves this through the application of prospective indices that are applied in April of each financial year and look ahead to the subsequent balance sheet date. A suite of indices is determined by the Department’s Senior Economic Advisor, in conjunction with the Defence Analytical Services Agency. Different indices are used for the following asset categories and are ‘self correcting’ in the subsequent financial year i.e. they are adjusted to account for the actual change in prices as compared to the earlier prediction:

• Land (by region and type)

• Buildings (UK and specific overseas indices)

• Fighting Equipment (one index for each of the three Sea, Air and Land systems)

• Plant, Machinery and Vehicles – Motor Vehicles and Trailers

• Plant, Machinery and Vehicles – Other Transport Equipment

• Plant, Machinery and Vehicles – Machinery and Equipment

• IT and Communications Equipment – Office Machinery and Computers

• IT and Communications Equipment – Communications Equipment.

1.11 Additionally all fixed assets are subject to a quinquennial revaluation by external professional valuers in accordance with FRS15.

1.12 Assets in the course of construction (ACOC) are valued at cost and are subject to indexation. On completion they are released from the project account into the appropriate asset category.

1.13 The Department‘s policy on the capitalisation of subsequent expenditure under FRS15 is to separately account for material major refits and overhauls when their value is consumed by the Department over a different period to the life of the corresponding core asset and where this is deemed to have a material effect on the carrying values of a fixed asset and the depreciation charge. Subsequent expenditure is also capitalised where it is deemed to enhance significantly the operational capability of the equipment, including extension of life and when it is incurred to replace or restore a component of an asset that has been treated separately for depreciation purposes.

Intangible Assets

1.14 Pure and applied research costs are charged to the Operating Cost Statement in the period in which they are incurred.

1.15 Development costs are capitalised where they contribute towards defining the specification of an asset that will enter production. Development costs not capitalised are charged to Other Operating Costs. The development costs are amortised over the planned operational life of that asset type, e.g. class of ship or aircraft, on a straight-line basis. Amortisation commences when the asset type first enters operational service within the Department. If it is decided to withdraw the whole or a significant part of an asset type early, then a corresponding proportion of any remaining unamortised development costs are written off to the Operating Cost Statement along with the underlying tangible fixed assets. For the purposes of development costs, a significant withdrawal of assets is deemed to be 20% or greater of the total of the asset class.

Tangible Fixed Assets

1.16 The useful economic lives of tangible fixed assets are reviewed annually and adjusted where necessary. The maximum capitalisation threshold is £10,000.

1.17 In these financial statements, guided weapons, missiles and bombs (GWMB) and capital spares are categorised as fixed assets and subject to depreciation. The depreciation charge in the Operating Cost Statement also includes the cost of GWMB fired to destruction. The principal asset categories and their useful economic lives, depreciated on a straight line basis, are:

Donated Assets

1.18 Donated assets (i.e. those assets that have been donated to the Department or assets for which the Department has continuing and exclusive use but does not own legal title and for which it has not given consideration in return) are capitalised at their current valuation on receipt and are revalued/depreciated on the same basis as purchased assets.

1.19 A donated assets reserve represents the value of the original donation, additions, any subsequent professional revaluation and indexation (MHCA) or a professional valuation. Amounts equal to the donated asset depreciation charge, impairment costs and deficit/surplus on disposal arising during the year, are released from this reserve to the Operating Cost Statement.

Impairment

1.20 The charge to the Operating Cost Statement in respect of impairment arises on decision to sell a fixed asset and take it out of service; on transfer of a fixed asset into stock; on reduction in service potential and where the application of MHCA indices causes a downward revaluation below the historical cost and which is deemed to be permanent in nature. Impairment also includes the cost of capital spares that are embodied into a fixed asset, as part of a major refit and overhaul, but which cannot be capitalised in accordance with FRS 15. Any reversal of an impairment cost is recognised in the Operating Cost Statement to the extent that the original charge was recognised in the Operating Cost Statement. The remaining amount is recognised in the revaluation reserve.

Disposal of Tangible Fixed Assets

1.21 Disposal of assets is handled by two specialist agencies: Defence Estates for property assets and the Disposal Services Agency for non-property assets.

1.22 Property assets identified for disposal are included at the open market value with any resulting changes in the net book value charged to the Operating Cost Statement under Impairment or credited to the revaluation reserve as appropriate. On subsequent sale the surplus or deficit is included in the Operating Cost Statement under surplus/deficit on disposal of fixed assets.

1.23 Non-property assets are subject to regular impairment reviews. An impairment review is also carried out when a decision is made to dispose of an asset and take it out of service. Any write down in value to the net recoverable amount (NRA) is charged to the Operating Cost Statement under Impairment. The surplus or deficit at the point of disposal is included in the Operating Cost Statement under surplus/deficit on disposal of fixed assets. Non-property assets, where the receipts on sale are anticipated not to be separately identifiable, are transferred to stock at their NRA and shown under assets declared for disposal. Any write down on transfer is included in the Operating Cost Statement under Impairment.

1.24 Disposals exclude fixed assets written off and written on. These items are included within Other Movements in Notes 7 and 8.

Leased Assets

1.25 Assets held under finance leases are capitalised as tangible fixed assets and depreciated over the shorter of the lease term or their estimated useful economic lives. Rentals paid are apportioned between reductions in the capital obligations included in creditors, and finance charges charged to the Operating Cost Statement. Expenditure under operating leases is charged to the Operating Cost Statement in the period in which it is incurred. In circumstances where the Department is the lessor of a finance lease, amounts due under a finance lease are treated as amounts receivable and reported in Debtors.

Private Finance Initiative (PFI) Transactions

1.26 Where the substance of the transaction is that the risks and rewards of ownership remain with the Department, the assets and liabilities remain on the Department’s Balance Sheet. Service charges in respect of on-balance sheet PFI deals are apportioned between reduction in the capital obligation and charges to the Operating Cost Statement for service performance and finance cost. Where the risks and rewards are transferred to the private sector the transaction is accounted for in the Operating Cost Statement through service charges in accordance with FRS 5 and Treasury Guidance.

Investments

1.27 Investments represent holdings that the Department intends to retain for the foreseeable future. Fixed asset investments are stated at market value where available, otherwise they are stated at cost. They include the Public Dividend Capital of those Executive Agencies owned by the Department and established as Trading Funds. Investments may either be equity investments, held in the name of the Secretary of State for Defence, or medium or long-term loans made with the intention of providing working capital or commercial support.

1.28 Joint Ventures are accounted for using the Gross Equity method of accounting. Under this method the Department’s share of the aggregate gross assets and liabilities underlying the net equity investments are shown on the face of the Balance Sheet. The Operating Cost Statement includes the Department’s share of the investee’s turnover.

Stocks and Work-in-Progress

1.29 Stock is valued at current replacement cost, or historical cost if not materially different. Provision is made to reduce cost to net realisable value (NRV) where there is no expectation of consumption or sale in the ordinary course of the business. Stock provision is released to the operating costs on consumption, disposal and write-off.

1.30 Internal Work-in-Progress represents ongoing work on the manufacture, modification, enhancement or conversion of stock items. This is valued on the same basis as stocks. External Work-in-Progress represents ongoing work on production or repair contracts for external customers. This is valued at the lower of current replacement cost and NRV.

1.31 Assets declared for disposal include stock held for disposal and those non-property fixed assets identified for disposal where receipts are not anticipated to be separately identifiable.

1.32 Stocks written-off, included within other operating costs, represents the book value of stock which has been scrapped, destroyed or lost during the year, and adjustments to agree the book values with the figures shown on the supply systems.

Provisions for Liabilities and Charges

1.33 Provisions for liabilities and charges have been established under the criteria of FRS12 and are based on realistic and prudent estimates of the expenditure required to settle future legal or constructive obligations that exist at the Balance Sheet date.

1.34 Provisions are charged to the Operating Cost Statement unless they have been capitalised as part of the cost of the underlying facility where the expenditure provides access to current and future economic benefits. In such cases the capitalised provision will be depreciated as a charge to the Operating Cost Statement over the remaining estimated useful economic life of the underlying asset. All long-term provisions are discounted to current prices by use of HM Treasury’s Test Discount Rate (TDR) which was 6% for the financial year 2002-03. The discount is unwound over the remaining life of the provision and shown as an interest charge in the Operating Cost Statement.

Reserves

1.35 The Revaluation Reserve reflects the unrealised element of the cumulative balance of revaluation and indexation adjustments on fixed assets and stocks (excluding donated assets and those financed by Government grants). The Donated Asset Reserve reflects the net book value of assets that have been donated to the Department.

1.36 The General Fund represents the balance of the taxpayers’ equity.

Pensions

1.37 Present and past employees are mainly covered by the CSP arrangements for civilian personnel and the AFPS for Service personnel. There are separate scheme statements for the AFPS and CSP as a whole.

1.38 Both pension schemes are contracted out, unfunded, defined benefit pay as you go occupational pension schemes, although they are being accounted for as if they were defined contribution schemes in accordance with the HM Treasury RAM. The employer’s charge is met by payment of an ASLC, which is calculated based on a percentage of pensionable pay. The ASLC represents an estimate of the cost of providing future superannuation protection for all personnel currently in pensionable employment. In addition, civilian personnel contribute 1.5% of salary to fund a widow/widower’s pension if they are members of Classic and 3.5% if they are members of Premium. The Department’s Balance Sheet will only include a creditor in respect of pensions to the extent that the contributions paid to the pension funds in the year fall short of the ASLC and widow/widower’s pension charges due.

1.39 The pension schemes undergo a reassessment of the ASLC contribution rates by the Government Actuary at three-yearly intervals. Provisions are made for costs of early retirement programmes and redundancies up to the normal retirement age and charged to the Operating Cost Statement.

1.40 The Department operates a number of small pension schemes for civilians engaged at overseas locations. These schemes have been accounted for in accordance with the application of SSAP 24 – Accounting for Pension Costs, as set out in the HM Treasury RAM. With effect from 1 April 2003 they will be accounted for in accordance with FRS 17 – Retirement Benefits once that standard fully replaces SSAP 24.

1.41 The disclosures required under FRS 17 are included in Note 2.4

Early Departure Costs

1.42 The Department provides in full for the cost of meeting pensions up to normal retirement age in respect of civilian personnel early retirement programmes and redundancies announced in the current and previous years. Pensions payable after normal retirement age are met by the CSP arrangements for civilian personnel.

1.43 There is no comparable early retirement or redundancy scheme for Service personnel but an immediate entitlement to draw pension under the AFPS accrues after 22 years’ service for other ranks and 16 years’ service for officers, or earlier in circumstances where exceptional approval is given.

Cost of Capital Charge

1.44 A charge, reflecting the cost of capital utilised by the Department, is included in the Operating Cost Statement and credited to the General Fund. The charge is calculated using the HM Treasury standard rate for financial year 2002-03 of 6% in real terms on all assets less liabilities except for:

• Donated assets and cash balances with the Office of HM Paymaster General (OPG) where the charge is nil.

• Liabilities for the amounts to be surrendered to the Consolidated Fund and for amounts due from the Consolidated Fund where the charge is nil.

• Assets financed by grants, where the charge is nil.

• Additions to heritage collections where the existing collection has not been capitalised, where the charge is nil.

1.45 The cost of capital charge on the fixed asset investments in the Trading Funds and in the Self Financing Public Corporation is calculated at a specific rate applicable to those entities, and is based on their underlying net assets.

Foreign Exchange

1.46 Transactions that are denominated in a foreign currency are translated into Sterling using the General Accounting Rate (GAR) ruling at the date of each transaction. US$ and Euros are purchased forward from the Bank of England. Monetary assets and liabilities are translated at the spot rate applicable at the Balance Sheet date and the exchange differences are reported in the Operating Cost Statement.

1.47 Overseas non-monetary assets and liabilities are subject to annual revaluation and are translated at the spot rate applicable at the Balance Sheet date and the exchange differences are taken to the revaluation reserve for owned assets, or the donated asset reserve for donated assets.

2. Staff Numbers and Costs

2.1 The average number of whole-time equivalent persons employed during the year was: Service 211,453 (2001-02: 210,178) and Civilian 92,358 (2001-02: 94,399). [Source: Defence Analytical Services Agency]

2.2 The aggregate staff costs, including grants and allowances paid were as follows:

2.3 For the year ended 31 March 2003 the salary, pension entitlements and the value of any taxable benefitsin- kind for Ministers in respect of their services to the Department is detailed below and should be read in conjunction with the following notes.

Ministerial Salaries and Allowances

† The presentation below is based on payments made by the Department and thus recorded in these Accounts. In respect of Ministers in the House of Commons, Departments bear only the cost of the additional ministerial remuneration. The salary for their services as an MP £55,118 pa with effect from 1 April 2002 (2001-02 £49,822 pa with effect from 1 April 2001 rising to £51,822 pa with effect from 20 June 2001), and various allowances to which they are entitled are borne centrally by the House of Commons. However, the arrangements for Ministers in the House of Lords is different in that they do not receive a salary but rather an additional remuneration which cannot be quantified separately from their Ministerial salaries. This total remuneration, as well as the allowances to which they are entitled, is paid by the Department and is therefore shown in full in the figures below.

** Lords Ministers’ Night Subsistence paid to The Lord Bach of Lutterworth was £27,133 in 2002-03 (£20,460 in 2001-02). (2001-02 £3,593 to The Right Honourable Baroness Symons of Vernham Dean). These figures are included in the salary figures disclosed. No Minister received payment of the London Supplement allowance this year.

Ministers who have not attained the age of 65, and who are not re-appointed to a relevant Ministerial or other paid office within three weeks, are eligible for a severance payment. No such payments were made in 2002-03 or the previous year.

Ministerial Pensions

Pension benefits to Ministers are provided by the Ministerial Pension Scheme (MPS) which is part of the Parliamentary Contribution Pension Fund (PCPF) for Members of Parliament. The MPS provides benefits on a ‘final salary’ basis with a 1/50th accrual rate, taking account of all service as a Minister. Benefits are payable on retirement from ministerial office on or after age 65, or on the payment of benefits under the main PCPF scheme. Members pay contributions of 6% of their Ministerial salary. There is also an employer contribution of 7.5% of the Ministerial salary paid by the Exchequer. In the event of retirement because of serious ill health, the MPS pension is brought into payment immediately. On death, pensions are payable to the surviving spouse at a rate of five-eighths of the Minister’s pension. On death in service, the MPS provides for a lump sum gratuity of three times the Ministerial salary. Pensions increase in payment in line with changes in the Retail Prices Index. On retirement, it is possible to commute part of the pension for a lump sum.

As the House of Commons and not the Department meets the Exchequer contribution to the cost of pension provision for Ministers, the pension details are included in the Resource Account on a ‘for information basis’.

Exceptionally as part of the arrangements for introducing disclosure of Ministerial pensions, for the purposes of disclosure in the 2001-02 resource accounts, Departments were instructed to include only those Ministers who were in post on 31 March 2002. For subsequent resource accounts disclosure will include those who left before the end of the reporting year.

Benefits-in-kind for Ministers

Minister’s private use of Official cars is exempt under the rules governing the definition of taxable benefits-in-kind. Mr Hoon was provided with living accommodation from 1 October 2002. The value of the benefit is calculated in accordance with the Inland Revenue regulations. No tax is charged on the living accommodation itself; a charge is made on the value of associated services, limited to 10% of the taxable Ministerial salary.

Figures for 2002-03 in bold, 2001-02 in italics

	Age	Salary (as defined below)	Real Increase/ (Decrease) in Pension at retirement	Total Accrued Pension at retirement as at 31 March	Taxable Benefits- in-kind (to nearest £100)	Until/From
		£000	£000	£000	£
Secretary of State for Defence:
The Right Honourable Geoffrey Hoon, MP †	49	65-70	0-2.5	5-10	3,500
	48	60-65	0-2.5	0-5	Nil
Parlimentary Under Secretary of State and Minister of State for Defence Procurement:
The Lord Bach of Lutterworth † **	56	90-95	0-2.5	5-10	Nil
	55	60-65	0-2.5	0-5	Nil	11 June 2001
The Right Honourable Baroness Symons of Vernham Dean † **	50	15-20			Nil	10 June 2001
Minister of State for the Armed Forces:
The Right Honourable Adam Ingram JP,MP †	56	35-40	0-2.5	0-5	Nil
	55	25-30	0-2.5	0-5	Nil	11 June 2001
Mr John Spellar, MP †	54	5-10	Nil	Nil	Nil	10 June 2001
Parliamentary Under Secretary of State for Defence and Minister for Veterans:
Dr Lewis Moonie, MP †	56	25-30	0-2.5	0-5	Nil
	55	25-30	0-2.5	0-5	Nil
Salary includes gross salary, performance pay and allowances paid.

A. The salary, pension entitlements and the value of taxable benefits-in-kind for the Department’s senior management board, the DMB, were as below.

Figures for 2002-03 in bold, 2001-02 in italics

Benefits-in-kind figures for civilian members of the DMB represent the value obtained from the private use of official cars, and for Service members of the DMB represents the value obtained from use of Official Service Residences. The Department has an arrangement with the Inland Revenue where MOD pays the tax liability that would ordinarily be paid by the individual. The tax liability consists of income tax, and where applicable, employees NIC. This tax liability is therefore included in the figures disclosed to arrive at the full ‘value’ of the benefit to the individual.

Details of Chief Executives and other senior staff of agencies are given in the agency accounts.

Pensions

2.4 The Civil Service Pension Scheme (CSP) and Armed Forces Pension Scheme (AFPS) are unfunded multiemployer defined benefit schemes but the Ministry of Defence is unable to identify its share of the underlying assets and liabilities. A full actuarial valuation was carried out at 31 March 1999 for the CSP and at 31 March 1997 for the AFPS. Details can be found in the resource accounts of these schemes which are published and laid before the House of Commons. The CSP accounts are also available on the web at www.civilservice-pensions.gov.uk.

For 2002-03, employers’ contributions of £211,677,542 in respect of civilian staff were payable to the OPG (2001-02: £210,648,857) at one of the four rates in the range of 12 to18.5 per cent of pensionable pay, based on salary bands. Rates will remain the same for the next two years, subject to revalorisation of the salary bands. Employer contributions to the CSP are to be reviewed every four years following a full scheme valuation by the Government Actuary.

For Service personnel, employers’ contributions of £1,146,025,835 (2001-02: £1,094,449,935) were also made to the AFPS based on rates determined by the Government Actuary plus £4,842,554 (2001-02: £3,592,982) of additional voluntary contributions and transfers in from other schemes. The applicable rates were 33.8% of pensionable pay for Officers and 18.2% for other ranks. (Employers’ contributions to the AFPS are to be reviewed during 2002-03).

The contribution rates reflect benefits as they are accrued, not when costs are actually incurred, and reflect past experience of the scheme.

2.5 Certain other employees are covered by other schemes such as the NHS Superannuation Scheme and the Teachers’ Superannuation Scheme. Contributions to these schemes in 2002-03 are included within the amount of £211,677,542 shown in Note 2.4 above.

3. Other Operating Costs

* In 2002-03, civilian short-term detached duty costs, amounting to £236,797,000, were included in Other
Expenditure; in prior years, these were included within movements.

† Loss on sale of shares in QinetiQ Holdings Limited to The Carlyle Group:

The net proceeds represent a proportion of the agreed debt and cash free enterprise value of the business.
See Note 9 for details on loan repayments.

4. Operating Income

5. Net Interest Payable

6. Reconciliation of Net Operating Cost to Control Total and Net Resource Outturn

	2002-03	Restated (Note 26) 2001-02
	£000	£000
Net operating cost (Schedule 2)	41,793,591	33,475,629
– Add income scored as Consolidated Fund Extra Receipts and included in operating income and interest	39,197	77,943
– Adjustment in respect of Machinery of Government changes	–	(34,901)
– Proceeds on part disposal of QinetiQ included in operating costs	39,427	–
– Prior year adjustment (Note 26)	141,469	–
	42,013,684	33,518,671

Net operating cost is the total of expenditure and income appearing in the Operating Cost Statement. Net resource outturn is the total of those elements of expenditure and income that are subject to parliamentary approval and included in the Department’s Supply Estimate. The outturn against the Estimate is shown in the Summary of Resource Outturn (Schedule 1).

7. Intangible Assets

Note:
i. Intangible asset valuations are based on the actual costs incurred over time, where available, or derived by applying a ratio to the tangible fixed asset valuations based on the historical relationship between development and production costs. The intangible asset valuations were indexed using the appropriate Gross Domestic Product (GDP) deflator to determine the opening balance sheet valuation;

ii. Intangible assets include development expenditure in respect of fixed assets in use and assets in the course of construction where the first delivery into operational use of the asset type has taken place;

iii. Additions on intangible and tangible fixed assets (Note 8) include accruals amounting in total to £2,066,322,000 (2001-02: £1,690,228,000); and

iv. Other movements comprise reclassifications to tangible fixed assets and transfer to operating costs.

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Section 2: Chapter 26b »

Last Updated: 3 Dec 03