Audit Committee,

Meeting date: Tuesday, May 17, 2005

Official Report 249KB pdf

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Section 22 Reports

Item 4 on the agenda is a briefing from the Auditor General for Scotland on section 22 reports on the 2003-04 audit of three colleges.

I have made three reports under section 22 of the Public Finance and Accountability (Scotland) Act 2000. They relate to West Lothian College, Inverness College and Lews Castle College. All three colleges have experienced financial difficulties for some time. The reports relate to the 2003-04 financial year, which ended on 31 July 2004. All three colleges were the subject of reports in relation to the prior financial year, 2002-03. In no case has there been a qualification of the accounts of the colleges, but the auditors have noted some concerns about the long-term sustainability of services in all the colleges, because of the financial problems that the colleges seem to be encountering.

Back in 1999, West Lothian College agreed a private finance initiative contract for its main campus facilities. That was approved by the Scottish Office before the creation of the Scottish Further Education Funding Council. The financial case for the PFI deal involved important assumptions about the future growth of the college, in relation to student numbers and the funding that that would attract in line with policy at that time. However, the grant that relates to funding has been lower than the level assumed in the PFI model. The funding council committed itself to providing £42 million over 25 years to support the PFI contract payments. In the financial year 2003-04, that support was £2.8 million. However, the annual financial support from the funding council is likely to reduce from about 2007. The consequence is that, without a significant increase in other funding, the college will not be able to meet its financial commitments.

Inverness College has been under financial pressure for some time. It obtained additional funding in 2002-03, which it was hoped would be a basis for future financial security. The college anticipated that its deficit would be eliminated by 2009. In the financial year 2003-04, it repaid some advances that it had received from the funding council, but it experienced poor trading results. The forecast small surplus turned into a deficit of £526,000. The funding council now believes that the college will be unable to clear its deficit on its income and expenditure reserve by the anticipated year of 2009.

The cash position of Lews Castle College worsened during 2002-03 and its bankers withdrew its overdraft facilities in December 2003. As a result, the college has had to manage its cash carefully in year. In 2003-04, the funding council gave the college a cash advance of £556,000 and the college is currently implementing and further considering a savings programme. The funding council is reviewing the funding of colleges in remote and sparsely populated areas and it has already allocated extra funds. The college is forecasting in-year surpluses in 2004-05 through to 2006-07.

I would be happy to answer any questions, with the assistance of Audit Scotland.

Inverness College forecast a surplus of £94,000, but that turned into a deficit of £526,000. Could you comment further on that? Was there a weakness in its forecasting system or did something happen that it was impossible to forecast?

The first point to make is one that I have made before, which is that section 22 reports are on what the auditors find as a result of the audit of the accounts. They are not the result of detailed, in-depth analysis of the situation. However, as a general point, there is clearly a big difference between predicting a surplus of £94,000 and returning a deficit of £526,000. The amount is large and, therefore, of concern. I should perhaps remind the committee, however, that we are talking about a college with an income of £13.4 million and that, relative to the size of the business, the sum is comparatively small, amounting to about 4 per cent of income in the year. The deficit also includes depreciation, which is a non-cash charge on the accounts. The situation is serious, but it should be related to the size of the business, which is also significant.

In a sense, then, it is the kind of difference that one might expect to arise occasionally.

I would not go that far. It is most unfortunate that a small surplus has been turned into a significant deficit. That should be avoidable by sound management.

In respect of West Lothian College, what were the agreed assumptions about funding growth in student activity on which the PFI case was made?

We do not have the exact numbers, but the projections when the PFI deal was struck were based on the level of activity that the college was delivering and assumptions on growth that were in line with the ministerial policy for the sector at the time. The contract was largely negotiated before the funding council took responsibility for the sector. The funding council's view, which it expressed to us, was that, although it did not inherit any commitment to provide growth in student-related activity, it had inherited a commitment to support the PFI deal through a schedule of payments that came to £42 million over the 25-year life of the deal. That schedule provides for a sliding scale of support throughout the period, which is likely to mean that the college will hit a serious problem around 2007.

Our understanding is that the plan was extremely reliant on growth in grant-aided funding. There might well have been assumptions about extra income from tailored courses and so on; I do not know. Now, the funding council is constraining funded growth to a level below the business targets because the extra funding is being distributed across the sector as part of the Executive's policy of consolidating the size of the further education sector rather than allowing for continuing growth at a local level.

So the payments that the funding council has agreed for the college bear no relation to the student numbers. Were they originally linked to the student numbers? I am trying to get some clarity about what the figures are based on and how the formula for supporting the college's PFI contract is worked out.

I can give you a general indication of that. The committee has previously taken evidence on the concept of the weighted student unit of measurement, which is the unit on which financing is based. In 2001-02, the college generated grant-aided student activity of about 52,500 weighted SUMs. It is presently constrained to 43,800 weighted SUMs. Therefore, the college has shown that it can generate a level of grant-aided student activity that is about 20 per cent higher than that which is currently being funded by the funding council. We are advised that it has turned away many students because of the current cap on its funding and that it believes that it could continue to generate the high level of activity that it experienced in earlier years.

I think that that says it all.

With regard to Inverness College's failure to return a surplus in the first year of its recovery plan, you say that the college has not been able to meet its target because of poor trading results. Could you clarify what you mean by that?

I am not sure that we can assist the committee terribly much in that regard. The question probably needs to be posed to the board. Bob Leishman might have further information.

The auditors' report to the Auditor General signals one area of significant cost increase during the year—staff costs—but it does not go into any greater detail on that point or relate it to increases in student activity.

It is quite worrying that the college is as far off its target as it is, given that this is the first year of its recovery plan.

It is a concern.

I was interested to hear the Auditor General say that the funding council was considering the funding of colleges in less populated areas.

I preface my comments by saying that the role that West Lothian College plays locally is significant in that it is the only further education facility in an area where there is a high percentage of young people and so is central to education there.

My questions are similar to those asked by George Lyon. The PFI settlement demanded certain results so as to enable West Lothian College to remain within budget. Because of a change of policy, the college has had to make some fairly difficult decisions over the past few years. Obviously, however, that is not bringing about a change in the financial circumstances. That change is presently being negotiated, so I was concerned to hear in the media this morning that the college was considering compulsory redundancies and had greatly increased the salary of its principal. However, I am told that none of that is correct: the college is not considering compulsory redundancies and it has not greatly increased the principal's salary. I wonder how such comments affect the sensitive negotiations that are going on around building a new financial package for the college.

When you were examining West Lothian College's settlement, Auditor General, did you have confidence in the way in which the college has progressed through a difficult period? Do you feel that the college's future is secure if it continues along the road that it has been following? Because of the way in which the policy changed, the college was always going to have to make some difficult decisions, but I think that it has done that. I do not want complications to be exacerbated by misinformation, particularly at such a sensitive time. Do you have any comments?

I am not sure that it would be appropriate for me to comment on the press coverage, as I am sure Mary Mulligan will understand. As I think I mentioned a moment ago, the past level of achieved activity shows that the college has been operating very successfully, as measured by the student numbers that it has attracted, and it has been constrained below that level. We have not done a full analysis of the college's business plan and its achievement, but the figures indicate that the college is thriving and has a future. However, it will have to meet the contractual commitments that it has entered into under the PFI agreement and it will have to address that with the funding council as a matter of urgency.

Was there anything in particular that you saw when looking at the reports that you would want to highlight for the college to address, or do you feel that that is part of the negotiating process that the college is going through at the moment?

The issue is primarily about the underpinning of the finance of the PFI deal going forward. Given the constrained student numbers, that is undoubtedly the biggest issue that the college faces.

As there are no further questions, I thank the Auditor General and his team for briefing us on those section 22 reports. The committee will return to deliberate on its response to those reports later in the meeting.