BACKGROUND NOTE, 13 January 2012

The national broadband network and the federal government budget statements

Brian Dalzell
Economics Section

Introduction

Recent media commentary and political debate has concerned the validity of the current accounting treatment of the national broadband network (NBN) in the federal government budget statements. This background note (BN) aims to explain how internationally accepted accounting standards are currently applied in the budget statement treatment of the NBN and how future NBN related transactions are likely to be treated under those standards.

This BN also aims to clarify some of the terms and arguments commonly used during commentary on this topic. For example, the terms on-budget and off-budget, and the notion that the accounting treatment of the NBN is dependent on the rate of return realised by the NBN, are discussed in the section below. The body of the note then examines the accounting treatment of past and potential future NBN related transactions, given three assumed stages of NBN activity.

Finally, this BN looks at whether the NBN can be accounted for as an expense item in the budget operating statement and then presents the methodology used to value the government’s equity investment in NBN Company (NBN Co).

Budget statement accounting of the national broadband network

Australia has adopted internationally accepted accounting standards and these are applied in the budget statement treatment of the NBN. The budget statement treatment of the NBN occurs primarily as a result of the government’s equity stake in the company charged with the rollout of the NBN, namely NBN Co.

While the applied accounting treatment depends on the specific transaction conducted between the government and NBN Co, this treatment is governed by accepted accounting standards and is applied equally to all government business entities (GBEs). This treatment is not determined by the return generated by NBN Co (or any other GBE).

Payments between the government and NBN Co (for example, dividends paid to government or adjustment of asset values) directly affect the budget statements. Such payments are indirectly affected by the success and therefore rate of return generated by NBN Co. However, this is in direct contrast to the idea that a return below a specific benchmark triggers an accounting rule where treatment of NBN Co is switched from ‘off-budget’ to ‘on-budget’ (see box 1 below). There is no such accounting rule.

Rather, the rate of return achieved will affect NBN Co’s capacity to make payments such as interest expense and dividend payments, or, if the NBN incurs losses, to potentially receive subsidy payments. As outlined in detail in the remainder of this BN, these payments, where they occur, are accounted for in the budget irrespective of the return generated by NBN Co.

Box 1: Are the terms ‘on–budget’ and ‘off-budget’ technical accounting terms?

To sum, accounting treatment does not depend on the realised rate of return of NBN Co, or whether that rate falls below a benchmark. In addition, the accounting treatment does not depend on whether the government intends to sell NBN Co in future. The sale, funding, operation and all payments stemming from these activities, are accounted for in the budget statements as per normal accounting procedures. These procedures are considered in detail below.

The NBN and the federal government budget statements

This BN concerns the budget statements of the general government sector (GGS) only. As illustrated in figure 1 below, the GGS does not include the public non-financial corporations (PNFC), or the public financial corporations (PFC) sectors. This BN will demonstrate however that transactions between entities in these sectors and the government are accounted for in the government budget statements.[1]

The three GGS budget statements of Budget Paper Number 1 are hereafter referred to as the government budget statements. The government budget statements comprise the:

•        GGS operating statement (the operating statement)

•        GGS balance sheet (the balance sheet statement); and

•        GGS cash flow statement (the cash flow statement).

Figure 1: Institutional structure of the public sector

Source: Australian Government, ‘Statement 9: budget financial statements’, Budget strategy and outlook: budget paper no. 1: 2011–12, Commonwealth of Australia, Canberra, 2011, p. 9-34, viewed 24 October 2011, http://cache.treasury.gov.au/budget/2011-12/content/download/bp1.pdf Note: the GGS includes government-controlled unincorporated enterprises that engage in market production but do not qualify as quasi-corporations because their operations are too closely integrated with the operations of other government units and are not the subject of a separate full set of accounts. More detailed definitions of the above sectors can be found in the glossary. NPIs are not-for-profit institutions.

For the purpose of this BN, NBN Co related transactions and their effects on the government budget statements are divided into three assumed stages of activity:

•        funding of NBN Co

•        operation of NBN Co; and

•        sale of NBN Co.

The accounting transactions for these three stages of activity are examined below. This BN considers these transactions in isolation, that is, in the absence of any other unrelated transactions, in order to isolate their individual effects on the budget statements.

During the actual government budget statement accounting exercise, the NBN related effects on the line items and accounting measures described below, could be outweighed by other, more sizeable transactions. It is however beyond the scope of this BN to consider these unrelated effects.

Funding of NBN Co

Initial funding involves government equity injections (for the purpose of this BN, the terms injection, investment and contribution are used interchangeably) in NBN Co.[2] These equity injections impact the balance sheet and the cash flow statement but not the operating statement.

The balance sheet statement

The balance sheet statement includes four financial indicators:

•        net worth – calculated as total assets minus total liabilities

•        net financial worth – calculated as total financial assets minus total liabilities

•        net financial liabilities – calculated as total liabilities less financial assets other than investments in other public sector entities; and

•        net debt – calculated as the sum of deposits held, government securities, loans and other borrowing, minus the sum of cash and deposits, advances paid, and investments, loans and placements.

The line items that comprise these calculations can be seen in figure 2 below.

Figure 2: Budget financial statements – balance sheet statement

Source: Australian Government, ‘Statement 9: budget financial statements’, Budget strategy and outlook: budget paper no. 1: 2011–12, Commonwealth of Australia, Canberra, 2011, p. 9-4, viewed 16 September 2011, http://cache.treasury.gov.au/budget/2011-12/content/download/bp1.pdf

Equity injections

Equity injections in NBN Co are recorded as an addition to the government’s financial assets in the balance sheet. Specifically, an increase in equity investments is recorded under the ‘investments in other public sector entities’ line item (the valuation methodology for these equity investments is explained in the ‘Departmental valuation of the government’s NBN Co equity investment’ section).

If equity injections are sourced from existing cash assets (for example, allocations in the Building Australia Fund) the composition of financial assets changes (from less ‘cash and deposits’ to more ‘investments in other public sector entities’). If equity is financed by debt issuance (for example, the sale of Commonwealth Government Securities (CGSs)), the effect on the balance sheet is to increase ‘investments in other public sector entities’ and increase ‘interest bearing liabilities’ (government securities).

Net worth and net financial worth are unaffected but net debt and net financial liabilities increase whether cash or debt is used to fund an equal sized equity injection in NBN Co. The mechanics of these effects are as follows.

Debt funded equity injections

While ‘interest bearing liabilities’ and ‘investments in other public sector entities’ increase when the government funds equity injections in NBN Co with debt, the net debt and net financial liabilities measures increase as a result, since both measures exclude ‘investments in other public sector entities’ in their calculation. That is, for both measures, the increase in liabilities is not offset by an increase in financial assets via increased ’investments in other public sector entities’. The net impact is an increase in the respective measures.

Cash funded equity injections

While ‘cash and deposits’ decrease and ‘investments in other public sector entities’ increase when the government funds equity injections in NBN Co with cash, the net debt and net financial liabilities measures increase as a result, since both indicators exclude ‘investments in other public sector entities’ in their calculation. That is, for both measures, the decrease in ‘cash and deposits’ is not offset by a proportionate increase in ‘investments in other public sector entities’, and the value of financial assets included in the measures decreases. The net impact is an increase in the respective measures.

To sum, an increase in debt (liabilities) or a decrease in cash (financial assets), and an equivalent equity injection in NBN Co, increases net debt and net financial liabilities, while net worth and net financial worth are unchanged.

The cash flow statement

The general government sector cash flow statement can be seen in figure 3 below. Transactions relating to NBN Co concern the ‘cash receipts from financing activities’ and ‘net cash flows from investments in financial assets for policy purposes’ line items.

In ‘cash receipts from financing activities’, the sub line-item, ‘borrowing’, relates to cash raised from government borrowing activities (that is, issuing CGSs). Debt issued for equity injections in NBN Co represent a net addition to this line item (borrowings are shown with a positive sign as cash flows from financing activities represent a net inflow).

In a given financial year, if the NBN Co related equity injection amount is equivalent to NBN Co related financing amounts (‘borrowing’), the net effect on the cash flow statement (the net increase/decrease in cash held) will be zero, as the two amounts exactly offset each other.

Subsequent equity injections in NBN Co are included in ‘net cash flows from investments in financial assets for policy purposes’. These cash flows have a negative sign as they represent a net cash outflow.

All else equal, if NBN Co financing amounts are greater than the equity injections in a given financial year, the net effect on the cash flow statement would be positive, that is, a net inflow. This is because the net cash inflows (from government borrowing) would be greater than the net cash outflows (from equity investments in the NBN Co), resulting in an increased cash balance (cash held).

All else equal, if NBN Co financing amounts are less than the equity injections in a given financial year, the net effect on the cash flow statement would be negative, that is a net outflow. This is because the net cash inflows (from government borrowing) would be less than the net cash outflows (from equity investments in NBN Co), resulting in a reduced cash balance.

The underlying cash balance does not include ‘net cash flows from investments in financial assets for policy purposes’ or ‘cash receipts from financing activities’ and is thus unaffected by changes in either line item.

The headline cash balance includes ‘net cash flows from investments in financial assets for policy purposes’ only, and is thus reduced by any NBN Co equity injection induced cash outflows.

The operating statement

The operating statement is not directly affected by NBN Co related equity injections.

Operation of NBN Co

Operation of NBN Co may affect the operating statement, cash flow statement and the balance sheet. Operation could result in payments to and from the government, for example, by dividends, interest payments, or return of capital.

Figure 3: Budget financial statements – cash flow statement

Source: Australian Government, ‘Statement 9: budget financial statements’, Budget strategy and outlook: budget paper no. 1: 2011–12, Commonwealth of Australia, Canberra, 2011, p. 9-5, viewed 16 September 2011, http://cache.treasury.gov.au/budget/2011-12/content/download/bp1.pdf

The operating statement

There are four potential transactions resulting from the operation of NBN Co, which could affect the general government sector operating statement (see figure 4 below). These are:

•        NBN Co payment of dividends to the government as shareholder

•        NBN Co payment of the government’s NBN-related cost of borrowing – interest received

•        NBN Co repayment of government equity contributions; and

•        government payment of subsidies to NBN Co.[3]

NBN Co payment of dividends

If NBN Co were to pay the government a dividend, the dividends received would be accounted for in the ‘dividend income’ line item of the revenue section of the operating statement. Dividends are a net addition to the budget. They act to decrease a budget deficit (or increase a budget surplus) as measured by the ‘fiscal balance’ (see the bottom of the operating statement).

Interest expense

All government costs of borrowing are treated as an interest expense in the government’s operating statement. NBN-related costs of borrowing comprise the interest payments on that amount of government borrowings that are used to fund equity contributions in NBN Co. Thus, the interest costs from borrowing to fund equity in NBN Co are also included in the ‘interest expenses’ line item and are not separately identifiable from other borrowings.

If NBN Co were to make payment(s) to the government specifically for these NBN-related costs of borrowing, these payments could be accounted for in the government’s operating statement (potentially in the ‘interest income’ or ‘other’ line items of the revenue section). This would offset the NBN-related borrowing costs in the ‘interest expenses’ line item of the expenses section.

The net impact of NBN-related interest expenses on the net operating balance would be zero if the NBN-related interest expense, and payment from NBN Co specifically for those expenses, matched exactly.

To sum, all interest paid on borrowings to fund government equity injections in NBN Co are accounted for as an interest expense in the operating statement. Where NBN Co does not make payment(s) to the government to compensate for these expenses (that is, they are not exactly offset by payments from NBN Co), they act to increase/reduce a budget deficit/surplus.

Figure 4: Budget financial statements – operating statement

Source: Australian Government, ‘Statement 9: budget financial statements’, Budget strategy and outlook: budget paper no. 1: 2011–12, Commonwealth of Australia, Canberra, 2011, p. 9-3, viewed 16 September 2011, http://cache.treasury.gov.au/budget/2011-12/content/download/bp1.pdf

Subsidy expenses

The Australian Bureau of Statistics’ Australian System of Government Finance Concepts, Sources and Methods, defines subsidy expenses as current grants paid by the general government to public and private enterprises including unincorporated enterprises. Subsidy expenses include grants made to public enterprises to offset recurring losses, which are generated by a government policy to maintain prices at a level that does not cover the cost of production.[4]

If NBN Co fails to generate sufficient revenue and incurs recurring operating losses, it could require a government subsidy in order to remain a going concern. A subsidy is treated as an expense in the government’s operating statement. NBN Co would treat the subsidies as income in its financial accounts.

If payments to NBN Co were to qualify as, or to be accounted for as a subsidy expense, it would represent an increase in expenses in the operating statement. This would increase a budget deficit or reduce a budget surplus (as measured by the fiscal balance).

Repayment of government equity contributions

Repayment of government equity contributions by NBN Co would not be classified as revenue and would therefore be excluded from the operating statement. Accounting for this transaction would take place entirely on the balance sheet.

The return of equity to the government (by NBN Co) would result in an increase in ‘cash and deposits’ (a debit in accounting terms) and a decrease in ‘investments in other public sector entities’ (a credit) on the balance sheet. Only the assets section of the balance sheet would be affected by this transaction.

The cash flow statement

There are five potential ways for the operation of NBN Co to affect the government’s cash flow statement. These are:

•        NBN Co payment of dividends to the government as shareholder

•        NBN Co payment of the government’s NBN-related cost of borrowing – interest received

•        government payment of NBN-related interest expenses – interest paid to bond holders

•        NBN Co repayment of government equity contributions; and

•        government payment of subsidies to NBN Co.

NBN Co payment of dividends

NBN Co payment of dividends to the government (as shareholder) would be accounted for as a positive addition to the ‘dividends and income tax equivalents’ line item in the cash receipts from operating activities section of the cash flow statement. This transaction would increase the underlying and headline cash balance measures (see figure 5 below).

Figure 5: Budget financial statements – cash flow statement (continued)

Source: Australian Government, ‘Statement 9: budget financial statements’, Budget strategy and outlook: budget paper no. 1: 2011–12, Commonwealth of Australia, Canberra, 2011, p. 9-6, viewed 16 September 2011, http://cache.treasury.gov.au/budget/2011-12/content/download/bp1.pdf

Interest received from NBN Co

The general treatment of interest receipts is in the cash flows from operating activities section. Consequently, interest payments received from NBN Co could be included in ‘interest receipts’ in the cash receipts from operating activities section of the cash flow statement. This transaction would reduce/increase an operating deficit/surplus as indicated by the ‘net cash flows from operating activities’ line item. Like dividends received from NBN Co, interest payments from NBN Co would increase the headline and underlying cash balance measures.

Interest paid to government bond holders

The ‘interest paid’ line item in the cash payments for operating activities section, accounts for interest payments made by the government on its issued debt/bonds (for example, CGSs). This includes any component of those bonds that are NBN-related.

Interest paid to government bond holders decreases the underlying and headline cash balance measures.

Government subsidies

Government subsidy payments to NBN Co would be accounted for as ‘grants and subsidies paid’ in the cash payments for operating activities section of the cash flow statement. Subsidy payments would decrease the headline and underlying cash balance measures.

Repayment of equity

A positive addition to ‘cash flows from investments in financial assets for policy purposes’ (a net inflow) would result, were NBN Co to repay government equity contributions. This would increase the headline cash balance but would not affect the underlying cash balance measure, as it does not include ‘net cash flows from investments in financial assets for policy purposes’.

If the government then uses this cash to repay debt (the principal component or face value of government issued bonds or CGSs), that payment represents a negative addition to ‘cash payments for financing activities’ (this transaction is referred to as a negative addition since these payments represent a net cash outflow). This transaction is not included in the headline or underlying cash balance measures.

The balance sheet statement

Operation of NBN Co could result in the following transactions which would be accounted for on the government’s balance sheet as outlined below:

•        NBN Co payment of dividends to the government as shareholder

•        NBN Co payments of the government’s NBN-related cost of borrowing – interest received

•        government payments of NBN-related interest expenses – interest paid

•        NBN Co repayment of government equity contributions; and

•        government payment of subsidies to NBN Co.

NBN Co payment of dividends

NBN Co payment of dividends to the government would be accounted for in the balance sheet as an increase in ‘cash and deposits’ (a debit in accounting terms). Net worth and net financial worth increase. Net financial liabilities and net debt decrease. As noted above, the dividend would be treated as revenue (a credit) in the operating statement.

Interest received from NBN Co

As with dividends, any NBN Co payments to the government, specifically intended to meet the interest expenses from NBN-related debt, could be accounted for in the balance sheet as an increase in ‘cash and deposits’. Net worth and net financial worth increase. Net financial liabilities and net debt decrease.

Interest paid to government bond holders

Interest payments to government bond holders by the government, are accounted for as a decrease in ‘cash and deposits’. Net worth and net financial worth decrease. Net financial liabilities and net debt increase.

Repayment of equity

If NBN Co were to repay government equity, these payments would increase the ‘cash and deposits’ line item. The repayment of equity by NBN Co would also mean a decrease in the ‘investment in other public sector entities’ line item. If the two flows are equivalent, the net impact on total financial assets would be zero. Net worth and net financial worth would be unaffected but net financial liabilities and net debt would decrease.

Government subsidies

Government payments to NBN Co that are accounted for as subsidies would reduce ‘cash and deposits’ on the balance sheet. This would decrease net worth and net financial worth and increase net financial liabilities and net debt. There would be no other effect on the balance sheet from the payment of subsidies to NBN Co.

Sale of NBN Co

The government must have an existing equity/ownership stake in NBN Co, if its sale/privatisation is to significantly affect the general government sector budget statements. The privatisation of NBN Co may have no effect on government budget statements, outside of any costs related to arranging the sale, where government equity contributions have already been repaid in full. In other words, the government cannot be compensated for an equity stake in NBN Co it does not have.

Therefore, the assumption here is that the government has a remaining equity investment prior to sale, in which case the government budget statements are affected by the privatisation of NBN Co as detailed below.

The operating statement

The government would incur costs in arranging the sale of NBN Co. The sale costs (payments to advisers, investment banks, etc.) would be recorded as an operating expense (potentially in the ‘other operating expenses’ line item of the operating statement). An increase in expenses would decrease a budget surplus and increase a budget deficit.

If the sale of NBN Co resulted in a gain or loss on equity, that is, the book value of the equity was not equal to the proceeds from the sale/privatisation of NBN Co, this would be accounted for in the operating statement through the ‘gain/loss on equity and on sale of assets’ line item.

The ‘gain/loss on equity and on sale of assets’ is a type of ‘below the line’ item and is not part of the net operating balance. Consequently, a gain or loss on equity, via the sale of NBN Co, would not be included in the calculation of the fiscal balance measure (the fiscal balance measure includes mainly above the line items) and therefore would have no impact on a budget deficit or surplus (as per the definition of fiscal balance in the operating statement). This is standard accounting practice.

The balance sheet statement

The sale of NBN Co would increase the ‘cash and deposits’ line item by the amount of the sale proceeds, while ‘investments in other public sector entities’ would decrease by a corresponding amount. If the increase in ‘cash and deposits’ is equivalent to the reduction in ‘investments in other public sector entities’, than total financial assets remain unchanged and net debt and net worth are unaffected. Net financial worth and net financial liabilities increase however, as they do not incorporate the reduction in ‘investments in other public sector entities’ as previously explained.

If the increase in ‘cash and deposits’ is greater than the reduction in ‘investments in other public sector entities’ (that is, NBN Co sale proceeds are greater than the book value of the corresponding equity), that would be recorded as a gain in the ‘gain/loss on equity and on the sale of assets’ line item in the other economic flows section of the operating statement. Total financial assets, net worth and net financial worth would increase while net financial liabilities and net debt would decrease.

The accounting entries for this transaction would consist of one debit and two credits. The debit entry would be to ‘cash and deposits’. The first credit entry would be to ‘investments in other public sector entries’ and the second would be to the ‘gain on equity and on sale of assets’ line item in the other economic flows section of the operating statement.

If the increase in ‘cash and deposits’ is less than the reduction in ‘investments in other public sector entities’ (that is, NBN Co sale proceeds are less than the book value of the corresponding equity), that would be accounted for as a loss in the ‘gain/loss on equity and on the sale of assets’ line item in the other economic flows section of the operating statement. Total financial assets, net worth and net financial worth would decrease while net financial liabilities and net debt would increase.

The cash flow statement

The sale of NBN Co represents a positive inflow (increase) to the ‘net cash flows from investments in financial assets for policy purposes’ line item. This increase does not affect the underlying cash balance measure however, as this measure includes only:

•        net cash flows from operating activities and investments in non-financial assets; plus

•        finance leases and similar arrangements; less

•        future fund earnings (see figure 5).

However, the headline cash balance does include ‘net cash flows from investments in financial assets for policy purposes’ and would subsequently increase as a result of this transaction.

In sum, the headline cash balance measure includes ‘net cash flows from investments in financial assets for policy purposes’ in its calculation, while the underlying cash balance does not. Therefore, were the government to privatise NBN Co, the proceeds would be accounted for as a positive inflow to ‘net cash flows from investments in financial assets for policy purposes’. The headline cash balance would increase as a result, while the underlying cash balance would be unaffected.

Can the NBN be accounted for as an expense item in the budget operating statement?

In the budget statement, the NBN is accounted for as a financial asset (equity investment) under the ‘investments in other public sector entities’ line item of the balance sheet. The NBN is not accounted for on the operating statement as an expense item, because it cannot be defined as such under accepted accounting standards.

The Statement of Accounting Concepts (SAC) as produced by the Public Sector Accounting Standards Board of the Australian Accounting Research Foundation and the Australian Accounting Standards Board defines expenses as:

consumptions or losses of future economic benefits in the form of reductions in assets or increases in liabilities of the entity, other than those relating to distributions to owners, that result in a decrease in equity during the reporting period.....where future economic benefits will be consumed or will expire during the current reporting period as consumable stores are used (emphasis added).[5]

In relation to equity injections in NBN Co, whether funds are obtained through the issuing of debt (an increase in liabilities) or existing cash balances (a reduction of cash assets), money transferred to NBN Co does not reduce balance sheet equity (assets minus liabilities)[6] and will not be consumed or expire, during the current reporting period. Therefore, cash transfers to NBN Co cannot be accounted for as an expense item in the operating statement.

However, as previously explained, a future reduction in the book value of that equity investment (financial asset) in NBN Co is accounted for as an expense in the operating statement:

In some cases, the reduction in future economic benefits which gave rise to an expense during the reporting period may have been initiated by the entity with the objective of causing a concurrent increase in future economic benefits in the form of an asset, but may have failed to do so. For example, where an entity makes expenditures as part of a research and development programme with the objective of generating future economic benefits in the form of a new product or process, and the expenditures fail to give rise to an asset that qualifies for recognition, the expenditures would meet the definition of expenses.[7]

Thus, if the government’s equity stake in NBN Co was eventually worth less than the equity contributions made to NBN Co, this would qualify as an expense. That expense would be captured in the ‘gain/loss on equity and on sale of assets’ line item of the operating statement. However, as this expense is part of other economic flows (a below the line item), it is not part of the fiscal balance measure and will have no impact on a budget surplus/deficit (as explained in the ‘Sale of NBN Co’ section above).

Conclusion

In sum, money transferred to NBN Co cannot be classified as an expense under currently accepted accounting standards. It is accounted for as a financial asset on the balance sheet (an ‘investment in other public sector entities’), as opposed to an expense item on the operating statement. An eventual gain or loss on the government’s equity investment in NBN Co is accounted for in the operating statement as an expense, but this does not affect the fiscal balance measure.

Departmental valuation of the government’s NBN Co equity investment

Administered investments

The government’s equity investment in NBN Co is considered an administered investment, as defined in the Finance Minister’s Orders for Financial Reporting (FMOFR) document, which states that:

Administered items include:

(i)            all taxes, statutory fees, fines, excises, subsidies, grants and transfers to and from individuals or organisations outside the Government (emphasis added).[8]

The same document defines administered investments as:

an investment by the Australian Government in a subsidiary, associate or jointly controlled operation or entity that is disclosed in the financial statements of an agency on behalf of the Australian Government.[9]

Administered investments include companies and authorities such as NBN Co that are not considered controlled by the entity that reports on them (in this case the Department of Broadband, Communications and the Digital Economy (DBCDE)).[10]

Administered investments must be disclosed in the financial statements by all related entities, and, other than those investments held for sale, must be measured at fair value.[11]

Valuation of administered investments

Among the accounting techniques available for valuation (measuring the fair value) of an administered investment are the discounted cash flow and the net asset valuation methods. The FMOFR document defines these as:

(a) Discounted cash flows - this method is recommended where an administered investment generates significant consistent cash flows. It is expected that this method will be used to value entities that generate significant cash flows from non-government sources; and

(b) Net assets - this method is most appropriate to apply when an entity invests in another entity that does not generate significant non-government cash-inflows or those cash flows cannot be reliably predicted. It is anticipated that this method will be used to value not-for-profit entities in the GGS. This method requires the investing entity to value its proportionate share of the other entity’s net assets as at current reporting date (even if it is yet to be audited).[12]

In relation to the valuation method chosen by the DBCDE to measure the fair value of the government’s equity investment in NBN Co (an administered investment), their 2010-11 annual report states that:

Administered investments in subsidiaries, joint ventures and associates are not consolidated because their consolidation is relevant only at the whole of government level. Administered investments, other than those held for sale, are classified as 'available for sale' and are measured at their fair value as at 30 June 2011. Apart from the Australian Postal Corporation, fair value has been taken to be the net assets of the entities as at the end of the reporting period (emphasis added). The fair value of the Australian Postal Corporation is taken to be the discounted cash flow of the entity as at the end of the reporting period.[13]

The DBCDE has therefore applied the net asset valuation methodology to measure the fair value of its equity investment in NBN Co. Their annual report presents the results of that valuation exercise. For the year ended 30 June 2011, NBN Co was valued at $958.805 million.[14] This is 4.07 per cent of the total $23 551 million ‘investments in other public sector entities’ line item amount, as reported in the 2010-11 government balance sheet statement (see figure 2).

Glossary

Accrual accounting - an accounting method that measures the performance and position of a company by recognising economic events regardless of when the associated cash transactions occur. Economic events are recognized by matching revenues to expenses (the matching principle) at the time in which the transaction occurs rather than when payment is made (or received). This method allows the current cash inflows/outflows to be combined with future expected cash inflows/outflows to give a more accurate picture of a company's current financial condition.

Balance sheet - presents the financial position of a business at a particular date. It presents a view of the business as the holder of resources (assets), which are equal to the claims against those assets, namely, the business’s liabilities and the stockholder’s equity in the business.

Bond - a security which represents money that an entity borrows from the investment market (individuals, companies, governments, etc.). A bond is a promise to repay the amount borrowed (the principal), plus interest, at a specified rate, on specified future dates.

Bond holders/bond issuers - bond holders are creditors to the bond issuer. A creditor is someone or some entity that has lent money to another individual or entity (the debtor). Through the life of a bond, a bondholder receives interest payments and eventually the principal amount, from the bond issuer. The bond issuer borrows money from the bond holder, the bond holder lends money to the bond issuer.

Budget deficit - is produced by a negative fiscal balance measure in the operating statement. A negative fiscal balance occurs when government spending exceeds the funds the government receives from taxation and other revenue, in any financial year. A negative balance indicates that in addition to taxation and other revenue, the government is drawing on the resources of other sectors in the economy.

Budget surplus - is produced by a positive fiscal balance measure in the operating statement. A positive fiscal balance occurs when the funds the government receives from taxation and other revenue, exceeds government spending in any financial year.

Capital - refers to the financial resources (usually cash) available for use by an entity. A business can raise further capital by issuing debt, or raising equity (selling shares).

Cash flow statement - through an accounting period, the cash flow statement aims to explain an entity’s change in cash, in terms of operating, investing and financing activities. Net cash flows are the difference between the cash inflows and cash outflows.

Cost of borrowing - see interest.

Debt issuance - refers to the act of issuing or selling bonds. Bond issuance represents the borrowing of money from the purchasers of those bonds. See bond holders/bond issuers.

Dividends - are distributions to stockholders of assets (usually cash) generated by past earnings.

Equity - represents the residual claims, or residual interest of the owners of a business, to the net assets of that business. The net asset value is calculated as assets minus liabilities. Owner’s equity is equivalent to shareholder’s or stockholder’s equity.

Equity investment/equity injection - money that is invested in a firm by its owner(s) or holder(s) of common stock (ordinary shares) but which is not returned to the owner or stockholders in the normal course of business. Investors typically recover their equity investment when they sell their shareholdings to other investors, or when the assets of the firm are liquidated and the proceeds are distributed, after the firm's obligations have been satisfied.

Fair value - an estimate of the price an entity would realise if it were to sell an asset, or the price it would pay to relieve a liability. Where current prices are not available from an active liquid market, a valuation technique must be used to estimate fair value.

Financial asset - derives value through contractual claim. Stocks, bonds, bank deposits, etc, are all examples of financial assets. In contrast, tangible physical assets like land and property derive their value from their physical worth.

Financing - involves the obtaining of capital from owners and creditors. Owners supply equity (make equity investments as shareholders) in a business and creditors lend money (make debt available) to the business. Both debt and equity are forms of capital.

Fiscal balance - an accrual measure that shows whether the government has to borrow from financial markets to covers its activities. The fiscal balance is thus an accrual indicator of the financial impact of the government’s operations, on the rest of the economy. The purpose of this measure is to show whether the government, over the economic cycle, is saving enough to cover its own investment needs and not drawing on private sector savings.

The fiscal balance measure is calculated as revenue (mainly tax receipts), net of expenses from operations, plus revaluation adjustments (to remove items that do not impact on the fiscal balance), plus net capital investment (net investment in non-financial assets).

If the fiscal balance measure is positive, the government has a fiscal (budget) surplus, if negative, a fiscal (budget) deficit. A deficit indicates that the government is drawing on resources from other sectors in the economy.

General government sector (GGS) - the principal function of GGS entities is to provide non-market goods and services (for example, roads, hospitals, libraries) primarily financed by taxes, to regulate and influence economic activity, to maintain law and order, and to redistribute income by means of transfer payments.

The GGS comprises all government units of the Commonwealth Government, each state and territory government, each local government authority, and all resident non-market not-for-profit institutions (NPIs) that are controlled and mainly financed by those governments.

Also included in the sector are government-controlled unincorporated enterprises that engage in market production but do not qualify as quasi-corporations because their operations are too closely integrated with the operations of other government units and are not the subjects of a separate full set of accounts.

Uniform sector classification of all public universities is regarded as an overriding consideration and all have been classified to the general government sector.

Government business entity (GBE) - a Commonwealth authority or Commonwealth company as defined by the Commonwealth Authorities and Companies Act 1997 (CAC Act) and prescribed as a GBE under the Commonwealth Authorities and Companies Regulations 1997 (CAC Act Regulations).

Headline cash balance - is calculated in the cash flow statement by adding net cash flows from investments in financial assets for policy purposes and future fund earnings, to the underlying cash balance.

Interest bearing liability - a liability, such as a debt, or debt instrument such as a bond, on which interest is payable.

Interest/interest expense - is the cost of borrowing money, or the return from lending money, depending on whether one is the borrower or lender. The total amount of interest paid by the borrower is the product of the interest rate (rate of interest), the duration of the loan or debt instrument, and the principal amount (the amount borrowed from the lender). The amount of interest paid by an entity in a given year is recorded as an interest expense in its operating statement.

Interest paid/interest received - when an individual or entity borrows money from a willing lender, the borrower (or debtor) pays the lender (or creditor) interest, and repays the principal amount borrowed, through the course of the loan. The interest payments are accounted for by the debtor as interest paid, and as interest received by the creditor.

Interest rate - a rate which is charged or paid, in return for the use (borrowing) of money. An interest rate is often expressed as an annual percentage of the principal amount borrowed. It is calculated by dividing the amount of interest by the amount of principal.

Liabilities - present obligations of a business to pay cash, transfer assets, or provide services to other entities in the future.

Line item - a unit of information in a document, record, or accounting statement, shown on a separate line. Line items refer to a separately identified budget element.

Non-financial assets - an asset with a physical value such as real estate, equipment, machinery, gold or oil. Gold, for example, is considered a non-financial asset because it has inherent value based on its use in jewellery, electronics, dentistry, and ornamentation. Cash on the other hand is a financial asset because its value is based on what it represents as opposed to its physical worth.

Operating statement - also known as the profit and loss, or income statement, it summarises the revenues earned and expenses incurred by a business through a specific period of time. An entity demonstrates its profitability or otherwise through this statement.

Public financial corporation (PFC) - a government owned or controlled enterprise which engages in financial intermediation (that is, trades in financial assets and liabilities). PFCs include the Reserve Bank of Australia, government-owned borrowing authorities, insurance offices and home lending schemes.

Public non-financial corporation (PNFC) - a government owned or controlled enterprise whose main function is the provision of goods and services which are predominantly market-based, non-regulatory and non-financial in nature. PNFCs are financed through the sale of these goods and services to consumers. All or most of their production costs are recovered from consumers, rather than being financed from the general taxation revenue of government. Some enterprises do receive subsidies to make up for shortfalls incurred as a result of government policy, such as the provision of community service obligations at concessional rates.

Rate of return - the gain or loss on an investment over a specified period, expressed as a percentage increase or decrease over the initial investment cost. Gain on investment is considered to be any income received from the security plus any realised capital gain.

Retained earnings - is accumulated net income (revenues less expenses), over one or more accounting periods, less dividends.

Return on capital - the ratio of money gained or lost (whether realised or unrealised) on an initial capital amount invested.

Return on equity - the ratio of money gained or lost (whether realised or unrealised) on an initial equity amount.

Shareholder - any person, company, or other institution that owns at least one share in a company. Together, shareholders are the owners of a company. They have the potential to profit if the company profits, but that comes with the potential to lose if the company underperforms.

Subsidy - current grants paid by the general government to public and private enterprises including unincorporated enterprises. Subsidies include grants made to public enterprises to offset recurring losses, where those losses are generated by a government policy to maintain prices at a level that does not cover the cost of production.

Underlying cash balance - calculated as net cash receipts from operations (excluding future fund earnings), plus financing adjustments (to remove cash flows more appropriately viewed as financing in government financial statistics), plus net cash capital investment (net cash investment in non-financial assets).

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[1].               NBN Co is a government business enterprise that is part of the public non-financial corporations sector (see figure 1 below). While it is not part of the general government sector, transactions between NBN Co and the government are accounted for in the government budget statements using the same accounting standards that govern the accounting of transactions between any other government business entity or commonwealth authority in the public financial or public non-financial corporation sectors.

[2].               Historical government NBN Co equity injection amounts are available through NBN Co annual reports. See: NBN Co, Annual reports, NBN Co website, viewed 22 November 2011, http://www.nbnco.com.au/about-us/annual-reports.html Forecast or expected future government equity injection amounts are available in the government’s annual budget measures. For the 2011-12 forecast figures see: Australian Government, ‘Part 3: capital measures’, Budget measures: budget paper no. 2: 2011–12, Commonwealth of Australia, Canberra, 2011, p. 342, viewed 21 November 2011, http://cache.treasury.gov.au/budget/2011-12/content/download/bp2.pdf

[3].               Historical figures with respect to NBN Co payment of dividends, interest and repayment of government equity injections are available in NBN Co annual reports. These should also provide precise information regarding the amounts of any government subsidies or equity injections received. See: NBN Co, Annual reports, NBN Co website, viewed 22 November 2011, http://www.nbnco.com.au/about-us/annual-reports.html

[4].               Australian Bureau of Statistics (ABS), Australian System of Government Finance Statistics, Concepts, Sources and Methods, cat. no. 51514.0, ABS website, Commonwealth of Australian, 2005, p. 172, viewed 16 September 2011, http://www.ausstats.abs.gov.au/Ausstats/subscriber.nsf/0/2D66AE207A369C0FCA25775E00210B62/$File/55140_2005.pdf

[5].               Public Sector Accounting Standards Board of the Australian Accounting Research Foundation and the Australian Accounting Standards Board (AASB), Statement of Accounting Concepts SAC 4: Definition and Recognition of the Elements of Financial Statements, AASB website, 1995, pp. 41-42, viewed 16 September 2011, http://www.aasb.gov.au/admin/file/content102/c3/SAC4_3-95.pdf

[6].               Equity is calculated as total assets minus total liabilities. Where cash is used to fund the NBN Co, cash assets decrease but equity investments increase by an equivalent amount and equity is unchanged. Where debt is used to fund the NBN Co, liabilities increase but equity investments increase by an equivalent amount and equity is unchanged. Thus, while equity injections in NBN Co represent a consumption of future economic benefits, they do not necessarily result in a decrease in equity in the reporting period.

[7].               AASB, Statement of Accounting Concepts SAC 4: Definition and Recognition of the Elements of Financial Statements, op. cit., p. 42.

[8].               Department of Finance and Deregulation (DFD), Finance Minister’s Orders for Financial Reporting, incorporating policy and guidance, DFD website, Canberra, 2011, p.32, viewed 26 October 2011, http://www.finance.gov.au/publications/finance-ministers-orders/docs/2010-11-FMOs-including-Policy-and-Guidance.pdf

[9].               Ibid., p. 8.

[10].               The NBN Co is a body subject to the Commonwealth Authorities and Companies Act 1997 (CAC Act). It is part of the Broadband, Communications and the Digital Economy portfolio. See: Department of Finance and Deregulation (DFD), Table of bodies subject to the Commonwealth Authorities and Companies Act 1997 (CAC Act), DFD website, Canberra, p. 2, viewed 26 October 2011, http://www.finance.gov.au/financial-framework/cac-legislation/docs/CAC-body-list.pdf

[11].               DFD, Finance Minister’s Orders for Financial Reporting, op. cit., p. 90.

[12].               Ibid., p. 91.

[13].               Department of Broadband, Communications and the Digital Economy (DBCDE), Annual Report 2010-11, DBCDE website, Australian Government, Canberra, September 2011, p. 140, viewed 26 October 2011, http://www.dbcde.gov.au/__data/assets/pdf_file/0016/140227/DBCDE_Annual_Report_2010-11_Entire_report.PDF

[14].               Ibid., p. 166.