PUBLIC CAPITAL EXPENDITURE APPRAISAL AND CONTROL: CIRCULAR 1/83 ON CAPITAL EXPENDITURE GUIDELINES
DEPARTMENT OF FINANCE
Public Capital expenditure appraisal and Control Circular 1/83 on Capital Expenditure Guidelines
1. It has been a long-standing concern of the Department of Finance to ensure that public capital investment was properly planned, and supervised and that the expected returns from projects adequately remunerated the investment involved. Some Departments and State agencies had over the years developed and applied rigorous project appraisal techniques but it became increasingly apparent that these procedures were not being applied on a sufficiently wide and systematic basis throughout the public sector. This was highlighted by significant cost overruns and inadequate rates of return from some large public sector investment projects completed in the late-1970s and early 1980s. Accordingly, the Department of Finance decided in March 1983 to issue comprehensive Circular (1/83) to all Departments and State agencies with capital expenditures forming part of the Public Capital Programme defining and codifying procedures to be followed by them in planning and controlling investment.
Purpose of Circular 1/83
2. The purpose of Circular 1/83 was to ensure a systematic approach to capital project planning and implementation throughout the public sector. In particular it encouraged the review of and, where necessary, the improvement of planning and control procedures already in operation as well as providing guidelines for Departments and agencies in introducing formal procedures where none previously existed. The guidelines cover all aspects of project planning, ranging from preliminary appraisal to detailed evaluation to actual implementation. The Circular makes clear that responsibility for the design and implementation of detailed procedures consistent with the guidelines rests with individual Departments and agencies. This is for two reasons:-
(i)differences in procedure may be appropriate with different programmes;
(ii)capital appraisal is an integral part of the responsibility which departmental managements hold.
3. The guidelines define procedures for preliminary appraisal, detailed evaluation, and project management stages of investment. They are applicable to once-off projects as well as to ongoing capital programmes. They acknowledge that the size of projects will influence the extent to which all the steps outlined in the Circular are applied.
4. The salient features of the guidelines are as follows:-
(a) Preliminary Survey: This should be carried out on all projects to assess the needs, objectives and means of carrying out the project. All options should be explored including, where appropriate, the possibility of private sector involvement either independently or with State assistance/participation.
(b) Detailed appraisal: If the project/programme is shown to be sufficiently worthwhile by the preliminary survey, a detailed feasibility/investment appraisal study containing the following main elements should be carried out
(i)A clearly defined set of objectives for the project should be articulated
(ii)A statement of alternatives that would meet the objectives should be drawn up.
(iii)A statement of the constraints (viz technological, physical, financial and statutory) that impinge on the project, together with a listing of those alternatives that do not fall within the constraints.
(iv)In respect of each option identified:
-A list of the benefits and costs expected over the economic life of the project and underlying assumptions.
-A quantification of the benefits and costs in cash or other economic terms as appropriate.
-A statement of projected cash flows or a cost/benefit balanced sheet, as appropriate.
-Calculation of the values of the relevant decision criteria (e.g. net present value, cost/benefit ratio, internal rate of return, maximum effectiveness at least cost) and a test for sensitivity to changes in key variables.
-Identification, and whenever possible quantification, of the distributional effects of the costs and the benefits.
-An assessment of the pay-back period (where appropriate).
-A recommendation as to the preferred alternative should be specified.
(c) Review once approved in principle: Once the detailed evaluation has completed the need for the project should be reviewed. For investments of commercial state bodies, the financial returns should be calculated and should be greater than the average cost of funds over the life of the project. A test discount rate of 7%+ for high risk projects is recommended but lower risk projects would be acceptable at a lower margin. For non-commercial bodies investments the expected economic and social returns from the projects should be assessed and the criteria used to assess the returns explicitly defined. If the results of this appraisal prove positive, the way is clear to seek approval in principle from the appropriate sanctioning authority.
(d) Design and cost limits: The procedures to be adopted once approval in principle for the project is given include:
•establishing cost limits for the project
•preparing a comprehensive brief to enable a detailed design to be prepared
•referring project back to sponsoring agency where costs exceed standard pre-determined cost limits to determine the extent to which costs can be reduced. Depending on the outcome the project may need to be re-examined.
(e) Tenders: On completion of detailed design work tenders should be sought and in conformity to the standard Government conditions of contract. Fixed price contracts should be negotiated where feasible.
(f) Final review: The case for the project should be reassessed in the light of actual tender prices before approaching the sanctioning authority for a final decision.
(g) Project Management: There should be a clearly designated individual project manager to oversee the execution of the project. Major once-off projects with a value in excess of £10 million should have a cost control supervisory committee with responsibility for overseeing the project.
Follow-up action taken by the Department of Finance
5. The Department of Finance has urged the adoption by Departments and State agencies of rigorous investment planning and implementation procedures to which both they and the State agencies with which they deal are now applying project appraisal procedures in line with those specified in Circular 1/83. The 1984 Public Capital Programme booklet took up this theme by highlighting the more rigorous and systematic approach to the approval of public investment proposals now required under which all public investment must be justified by economic and/or financial appraisals. The National Plan “Building on Reality” stated that Government approval for investment will depend on the outcome of rigorous evaluation based on guidelines developed by the Department of Finance. The 1985 PCP Booklet drew attention to the fact that although progress has been made in this area, it was not enough.
6. A constraint on progress is the scarcity of trained staff. There is a need for more trained personnel throughout the public service skilled in project appraisal techniques. The Department of Finance plays a lead role selecting suitable officers to undergo intensive training, including taking a masters degree course, over a two year period under the aegis of the Department’s Analysis Section. On completion of this course, the Department of Finance assigns these officers to line Departments thereby enhancing the capabilities of such Departments to carry out thorough progress appraisals. In the two years since the issue of Circular 1/83 eight officials have been selected for training under the Analysis training programme.
Scope of Circular: Types of projects excluded/included
7. While Circular 1/83 is generally aimed at projects/programmes making up the PCP, there are some projects/programmes which fall outside its scope. These include, for example, loan finance advanced by agencies such as the Industrial Credit Company, Agricultural Credit Corporation, Fóir Teoranta, Housing Finance Agency and local authorities for houses. In the case of loans for commercial purposes the agencies in question apply normal commercial criteria. Housing loans are advanced to individuals who meet the conditions of the individual schemes. Also private housing grants and projects within the water supply and sewerage and private bog development grants schemes, by their nature do not come within the terms of Circular 1/83. On the other hand investments by commercial semi-State bodies fall within the terms of Circular 1/83. Investments in the productive infrastructure and social infrastructure areas are also covered by Circular 1/83 but these require a somewhat different approach to quantification that would, for example, be appropriate to commercial project appraisal.
State of Play on the Implementation of Circular 1/83
8. Commercial semi-State bodies falling within the remit of the Joint Oireachtas Committee on Commercial semi-State bodies lie outside the scope of this review. Their PCP expenditures accounted for 40% and 36% of the 1984 PCP and 1985 PCP respectively. The Circular applies, however, to their investments and indeed is in its financial approval aspects possibly more relevant to these investments than to many covered in this paper (e.g. those of a social nature). This explains why relatively few examples are to be found in the Appendix to this note of full scale financial analysis of investments and decision making based on financial rates of return.
9. Appendix I attached contains reports from Departments, on a Ministerial Group basis, supplied on request to the Department of Finance, on the extent to which investment appraisal guidelines are being implemented by them and their related agencies. Broadly speaking the guidelines are being implemented by Departments and agencies where they consider it appropriate to do so. The intensity with which they are applied varies, depending, inter alia, on the size and nature of the projects/programmes in question. In many cases Departments apply procedures of equivalent effect to that of Circular 1/83. But some Departments also feel that the quantitative evaluative provisions of the Circular are not fully, or in some cases, at all applicable to capital expenditures under their aegis, notably those of a social nature.
10. It is not possible to comment definitively at this stage on the effectiveness of Circular 1/83 in terms of the extent to which the productivity of public investment has been raised. This is so because several years elapse between the conception and the completion of many projects/programmes making up the PCP, and even then a period must elapse before the economic and/or social effectiveness of the project can be judged on the basis of its performance. The guidelines are proving effective however to the extent that for the first time there exists a systematic basis for planning and executing public sector projects. Moreover Departments and agencies now realise that the degree to which the Circular 1/83 or equivalent guidelines are applied will have a bearing on the selection of projects for inclusion in the PCP. In that sense the guidelines are facilitating in a practical manner the Government’s aim of having all capital projects rigorously evaluated before being considered for inclusion in the PCP.
11. More specifically the following examples indicate the progress made in improving capital expenditure evaluation and execution:
-A cost benefit study outline for major road projects is being tested on a pilot basis
-IDA have refined their comprehensive evaluation system for grants
-A number of project monitoring committees for projects costing in excess of £10 million have been established.
12. Many of the capital projects included in the 1984 and 1985 PCP’s were planned or initiated before the issue of Circular 1/83. The Department of Finance has, however, been assured by Departments generally that procedures broadly similar to Circular 1/83 were generally applied to those projects.
13. Where Circular 1/83 guidelines were not applied in the case of certain 1984 and 1985 PCP allocations; one or other of the following explanations apply:
(i)projects were planned and initiated prior to issue of Circular 1/83
(ii)PCP expenditures e.g. housing grants and loans are not covered by Circular 1/83
(iii)Circular 1/83 guidelines are not applicable to minor works.
Factors affecting the degree to which the Department of Finance is informed of the appraisal carried out by other Departments
14. Where projects require the specific prior sanction of the Minister for Finance and/or the Government, the Department of Finance is in a position to insist on the completion of in depth appraisals and does so. Large areas of the public capital programme with ongoing expenditures viz local authority housing, roads, schools and hospitals* are, however, administered by the responsible line Departments under delegated sanction given by the Minister for Finance. While in all cases it is the task of the sponsoring Department/Agency to carry out capital appraisals, the involvement of the Department of Finance in these exercises varies. In cases where delegated sanctions apply the Department of Finance would not normally be directly involved in the evaluation of individual projects and would not be fully conversant with all the details of these evaluations. In cases where the Minister’s sanction was required, the Department would be more involved and be more familiar with the details of capital appraisals on specific projects. The further development of appraisal will lead to greater involvement by the Department of Finance in capital expenditure projects generally.
Programmes of particular capital works
15. In certain cases the Government adopts a programme of particular capital works. An example is the roads programme recently announced by the Minister for the Environment; another was the accelerated development programme for the telecommunications network. When such programmes are proposed the Minister directly responsible is expected, in the first instance, to assess its financial, economic and, where relevant, social justification. The Department of Finance reviews such assessments, attempts, where appropriate to improve, or supplement them in consultation with the Department primarily responsible, considers the programme, and its financial needs, in the national budgetary and economic contexts and advises the Minister for Finance of its findings. Decisions on large programmes of this kind are normally taken by the Government. A Government decision to undertake such a programme does not, however, in the view of the Department of Finance, remove the requirement that individual projects which are part of the programme should be assessed, and shown to be justifiable before they are proceeded with.
* Projects costing less than £3 million exclusive of professional fees, furnishings and equipment.