Audit | Tax | Advisory

Grants and Contracts - Key matters to consider

CFG OSSIG meeting July 2014

Pesh Framjee Head of Not for Profit at Crowe Clark Whitehill

Special Advisor to the Charity Finance Group (CFG)

Arthur Blackburn Partner , VAT Group at Crowe Clark Whitehill

Grants or Contract

▸ A grant is outside the scope of VAT ▸ A grant is not a payment for a supply of goods nor services

▸ Charities receive grants to support their charitable activities ▸ A grant may still result in the charity having to explain how the money

is being used

Grants or Contract VAT Grants: Criteria KEY CRITERIA - GRANT ▸ Approach the funder ▸ Define how it will be spent ▸ Discretion to give money ▸ Change of mind ▸ A relationship of trust

Grants or Contract VAT Grants: Criteria KEY CRITERIA - GRANT ▸ Terms of restriction ▸ Good housekeeping ▸ Breach of trust ▸ Not purchasing a benefit

Grants or Contract VAT Grants: Criteria ▸ Often the word “grant” can be used incorrectly i.e. Local Authority

Funding, Service Level Agreements ▸ If it is not a grant it becomes a supply in the course and furtherance of

business.

Grants or Contract Business supply: Criteria ▸ Is the income received consideration for a supply? ▸ Does the grantor receive anything in return? ▸ If not the grantor, does a third party benefit? ▸ Is the charity under certain obligations to the grantor? ▸ Are they conditions attached to the provision of the money beyond

normal “house-keeping”? ▸ A breach of contract

Grants or Contracts

▸ A taxable business contract ▸ VAT liability “where the customer belongs” ▸ Consultancy contract with UK customer = Standard Rated Supply

Grants or Contracts

▸ A taxable contract has the benefit of full input tax recovery where there is no VAT burden to the customer

▸ Contracts with DFID, Overseas Aid ▸ DFID are procuring and paying for services that are being provided to

overseas governments ▸ By concession the supply to DFID is outside the scope of UK VAT

(with input tax deduction)

DFID funded INGOs are missing an opportunity

Overseas Government Service Supplier Invoice DFID

▸ Supplier charge to DFID outside the scope of UK VAT even though

DFID is in UK ▸ Supplier allowed to recover VAT incurred in relation to that contract ▸ Income is deemed “taxable” in relation to partial exemption thus

increasing overhead recovery

Accounting, direct tax and operational issues

Understanding the nature of income (Sorp extract)

There are two broad categories of income:

• income from exchange transactions (contract income)

• and income from non-exchange transactions (gifts).

It is important for charities to distinguish between the two as they are recognised differently in a charity’s accounts.

.

SORP definition of contract income Contract income is income received by a charity for the purpose of providing the goods or services under the terms of a legal contract. It is important that trustees establish from the outset whether the receipt of income is subject to a legally binding contract for the supply of goods or services.

SORP definition of grant income Grant income is any voluntary income received by the charity (or other transfer of property) from a person or institution. The income or transfer may be for the general purposes of the charity, or for a specific purpose. It may be unconditional or be subject to conditions which, if not satisfied by the recipient charity, may lead to the grant property acquired with the aid of the grant or part of it being reclaimed by the grant-maker.

SORP definition of contract Indicators of a contract for the supply of services are:

the payer, rather than the recipient charity, has taken the lead in identifying the services to be provided; and/or

the arrangement provides for damages to be paid in the case of a breach of its terms, rather than, for example, for total or partial refund of the payment made.

If there is no contract, the rights and obligations of the parties will depend primarily on the law of trusts and conditional gifts, rather than on the law of contract.

SORP definition of performance related grant

A performance related grant is one where the grant has the characteristics similar to those of a contract, in that:

the terms of the grant require the performance of a specified service that furthers the objectives of the grant maker; and

the entitlement to the grant receivable is conditional on a specified output being provided by the grant recipient

So don’t get too bogged down in what it is called – something called a grant may in fact be a contract

Does the difference matter?

Yes for VAT

Yes for accounting

Probably for operational issues

Not usually for direct tax

SORP Modified criteria for recognition of income

Entitlement – control over the rights or other access to the economic benefit has passed to the charity.

Probable – it is more likely than not that the economic benefits associated with the transaction or gift will flow to the charity.

Measurement – the monetary value or amount of the income can be measured reliably and the costs incurred for the transaction and the costs to complete the transaction can be measured reliably.

The three criteria might require different assessment for a contract as against a grant

FAQs on income recognition – see handout

1. Will the proposed modification of the income recognition criteria mean that charities will have to recognise more income and restate their income for prior periods when they adopt FRS102 and the new SORP?

2. Is grant income to be recognised differently from contract income?

3. When can we recognise income in line with related expenditure?

4. What about timing restrictions?

5. Can income be recognised in line with a funder’s stage payments?

FAQs on income recognition – see handout 6. What about grants provided for the purpose of purchasing

fixed assets?

7. At present we recognise the grant and donation income that we have received will we need to change this and defer some of the income?

8. What about legacy income – has the SORP changed the recognition?

9. What about gifts in kind?

Non compliance with terms

It is important at the outset of any arrangement that the charity identifies whether the funding agreement is a performance-related grant or a contract.

This is important because the consequence of non-compliance with performance-related conditions and the liability for non-performance of a contract differ.

The law of contract provides for the buyer to seek costs, damages and recompense for any failure or breach of contract by the seller, whereas a breach of grant conditions may lead to a partial or full repayment of the grant when repayment terms apply to the grant.

- SORP 2015 (5.9)

SORP - Substance over form

Transactions and events must also be accounted for with prudence and presented in a way that represents their substance and not merely their legal form. This will require the exercise of judgement and may on occasion dictate the disclosure of more information than specifically recommended in this SORP.

Charities must therefore consider the substance of any conditions attaching to donations or grants and to the substance of any contractual terms when determining their entitlement to income.

Similarly, the substance of any restriction placed on the use of income must be considered when determining whether or not income is presented as restricted funds in a charity’s accounts

Direct tax

Many charities provide products and services for a fee on a regular basis and these arrangements often develop into trading with consequential tax implications. In the move to a contracts many charities previously funded by grants are finding themselves within the trading net

Charities are exempt from direct tax on the profits of “primary purpose” trading activities. A primary purpose trade is one which is carried out as part of the charity’s primary charitable purpose or purposes

Also look out for

Prefinancing – the theory and the reality

Payment by results – How are results defined

Onerous terms - Who checks the agreement

Clawback - Common sense does not

Any further clarification

Pesh Framjee

Head of Non Profits

Crowe Clark Whitehill

St Bride’s House

Salisbury Square

London EC4Y 8EH

UK

nonproftis@crowecw.co.uk (helpline)

Pesh.framjee@crowecw.co.uk

Arthur.Blackburn@crowecw.co.uk

1

Frequently asked questions on income recognition

Crowe Clark Whitehill runs a help line for the Charity Finance Group (CFG). This guidance note considers some of the frequently asked questions from charities relating to income recognition.

Question1: Will the proposed modification of the income recognition criteria mean that charities will have to recognise more income and restate their income for prior periods when they adopt FRS102 and the new SORP?

I have heard the view expressed that FRS102 appears to have lowered the income recognition test and that it is likely that more income will be recognised with less deferral of income. However, I believe that any changes in the amounts recognised as income will be minimal.

To assess whether your charity has previously unrecognised income that now needs to be recognised, you need to understand what has changed and the implication of the change.

SORP 2005 explained that income should be recognised when all of the following three criteria are met:

1) entitlement – when there is control over the rights or other access to the resource enabling the charity to determine its future application

2) certainty – there should be reasonable certainty of receipt 3) measurement – the item can be measured monetarily with reasonable certainty.

The key change is to the ‘certainty’ requirement. Under the new rules the word ‘certainty’ has been replaced by ‘probable’. Probability of receipt is defined as meaning that it is more likely than not that the economic benefits associated with the transaction or gift will flow to the charity. The other two criteria are broadly unchanged.

When you assess the practical impact of this change you will have to consider why income was not recognised previously. If the reason was that there was no certainty of receipt but it was more likely than not that the income would be received, your income recognition is likely to change.

However, in my experience most charities that deferred income recognition did not recognise income because they thought that they were not entitled to the income at the accounting reference date. This test has not changed and if the reason why you did not recognise income was based on criteria 1) and/or 3) above then the modification of criteria 2) (reasonable certainty of receipt versus more likely than not) will not impact income recognition.

Entitlement is dependent on the type of income stream and the substance of the terms and conditions that may apply. .Charities need to identify donations or grants that are subject to terms or performance-related conditions or other conditions that must be met before there is unconditional entitlement to the gifted resources.

SORP 2015 emphasises that performance-related conditions are not the only conditions that may apply to donations and grants. For example, a grant may be conditional on a charity obtaining matched funding, or subject to a successful planning consent. Meeting these conditions would not be wholly within the control of the recipient charity and the outcome of the specified event is uncertain. The charity would not have unconditional entitlement to the income until these conditions were met.

2

Donor imposed conditions may also specify the time period over which the expenditure of resources on a service can take place. all these issues mean that there are many matters that could impact on income recognition and these are discussed further in this guidance note.

A change in an accounting policy must be applied retrospectively to comparative information for all prior periods to the earliest date for which it is practicable, except where an accounting standard requires or permits an alternative treatment on its first adoption. However, a change in an estimation technique is not a change in accounting policy and no adjustment is to be made in respect of prior reporting periods

Question2: Is grant income to be recognised differently from contract income?

Once again the focus needs to be on entitlement as the first of the income recognition criteria. FRS 102 makes the distinction between exchange and non exchange transactions. The former includes contracts for services and performance related grants and the latter includes gifts even if they are restricted. Entitlement to contracts and performance related grants will arise when the charity has earned the right to the income. Therefore with an exchange transaction income is recognised in line with performance.

Some accountants believe that only contracts would require the need to match income with performance but FRS102 explains that the same principles will apply to all income where there are related performance conditions and states:

“An entity shall recognise receipts of resources from non-exchange transactions as follows:

(a) Transactions that do not impose specified future performance-related conditions on the recipient are recognised in income when the resources are received or receivable.

(b) Transactions that do impose specified future performance-related conditions on the recipient are recognised in income only when the performance-related conditions are met.

(c) Where resources are received before the revenue recognition criteria are satisfied, a liability is recognised.”

A restriction on the use of a grant will not of itself create a performance related condition. A restriction simply creates a requirement that limits or directs the purpose for which a resource may be used but it does not prevent the recognition of income where it does not require a specific level of performance or output from the charity.

A performance related grant is one where the grant has the characteristics similar to those of a contract, in that:

the terms of the grant require the performance of a specified service that furthers the objectives of the grant maker; and

the entitlement to the grant receivable is conditional on a specified output being provided by the grant recipient.

Where entitlement to grant income is subject to performance conditions income is recognised as the performance conditions are met. In effect, a performance related grant is analogous to a contract for the supply of services. Income from the supply of services is recognised in line with the delivery of the contracted service provided that: the stage of the completion, the costs incurred in delivering the service and the costs to complete the requirements of the contract can all be measured reliably.

3

This begs the question as to how performance can be measured. SORP 2015 explains that a charity must select a method to measure the stage of completion of a service contract that provides the most reliable estimate of the right to receive payment for the work performed.

Possible methods include:

the proportion of costs incurred for work performed to date compared with the total estimated costs to completion; or

surveys of the work performed; or completion of a physical proportion of the service contract work.

The answer to question 3 provides more guidance on when using costs incurred may be appropriate.

It may also be appropriate to recognise income based on the time spent in providing a service as a proportion of the total time to be spent to fulfil the contract when this provides the most reliable estimate of a charity’s entitlement.

There is also the issue of whether funding agreements and contracts are sufficiently material to the activity of the period that failing to record turnover and attributable profit would lead to a distortion of the period's turnover and results such that the financial statements would not give a true and fair view.

The thinking is, that owing to the length of time taken to complete some contracts or funded projects, to defer recording income until completion may result in the accounts not reflecting a fair view of the results of the activity during the year. Instead, they would be based on the results relating to contracts that have been completed in the year. In certain cases, it is appropriate to take credit for ascertainable turnover and “profit” while contracts/ projects are in progress. Charities need to record income and related costs as contract activity progresses. Income should be ascertained in a manner appropriated to the stage of completion of the contract.

Question3: Does this mean that we can recognise income in line with related expenditure?

It is important to understand when such a treatment is possible. It should not be adopted on the basis of trying to match income and expenditure – the ‘matching’ concept which was much favoured by accountants has for some time been seen as inappropriate and contrary to accounting standards. FRS102 makes this quite clear and states:

“Generally this FRS does not allow the recognition of items in the statement of financial position that do not meet the definition of assets or of liabilities regardless of whether they result from applying the notion commonly referred to as the 'matching concept' for measuring profit or loss”

However, in certain circumstances a form of matching can be adopted. This is where the grant is performance related or the income is under a contract that requires the delivery of some service. The rationale for this treatment is based on the view that the performance related grants are analogous to performance related grants (as discussed above) and in some cases the most reliable method of assessing performance is considering the proportion of costs incurred for work performed to date compared with the total estimated costs to completion.

4

This may be the case even if there are specific deliverables. Sometimes, correlating the level of earned income with performance against these deliverables may be very difficult or the nature of the deliverables may not allow easy quantification of performance. For example, a funder might require the charity to sign up a specified number of people to a scheme and then deliver a certain level of training. At the year end date it might have signed on 70% of the required number of people and delivered 40% of the training – what is the level of consideration that it has earned?

In such cases expenditure may be the best proxy for performance and if so income can be recognised in line with expenditure. However, where there is other performance criteria specified in the funding agreement that can be measured, expenditure may not be the best approach.

It is important to recognise that simply incurring costs in relation to a contract does not in itself justify the recognition of income. For example if a charity has completed 50% of the work but incurred a greater proportion of costs and is not in a position to claim cost overruns leading to a “loss” on the contract it should take this into account when recognising income .

The expenditure criterion is used where the costs incurred and the costs to complete the transaction can be measured reliably. If the costs incurred and the costs to complete cannot be measured reliably then the receipt should be treated as an advance payment and deferred

Question 4: What about timing restrictions?

SORP 2005 explained that “Incoming resources may also be subject to donor imposed conditions that specify the time period in which the expenditure of resources can take place. Such a pre-condition for use limits the charity's ability to expend the resource until the time condition is met. For example, the receipt in advance of a grant for expenditure that must take place in a future accounting period should be accounted for as deferred income and recognised as a liability until the accounting period in which the recipient charity is allowed by the condition to expend the resource.”

This approach is unchanged and is applied where the donor specifies when the funding can be used and in such cases, a time restriction may require deferment of income. This is where there are specific conditions on when the funds can be used and it is not usually within the charities discretion to make use of the funds at an earlier stage. The nature of the agreement limits the charity's ability to expend the resource until the time condition is met.

Simply because the charity decides it cannot start or complete a funded project until a later accounting period does not mean that the income should be deferred. A charity retrospectively agreeing with the funder that unspent funds will not be clawed back is not the same as a condition that limits the charity’s ability to expend the funds.

But it is important to look beyond the obvious. For example, it may be clear from the funding application that the charity had asked for funding to cover a specific time period. The charity may have submitted a three year budget with the application indicating how much will be spent each year. In some cases the grant will be clearly to meet the salary of an employee over the next three years or pay the rent over the next three years. In such cases the grant agreement may specify that a specific amount of the grant relates to those three years. In many cases the agreed yearly amount or budget is specified with a clause that this cannot be varied without the funder’s agreement.

5

SORP 2015 has clarified this area and explains that time-related conditions may be implied, for example when a multi-period grant is approved and is to be paid on the basis of agreed annual budgets, the charity may not be entitled to spend part or all of that income in advance of its budgeted year(s) without the further prior approval of the grant-maker.

Therefore, If the application or the funding agreement specifies the period covered by the grant it may be correct to recognise the income over this period. This is not sanctioning income recognition in line with stage payments (see Question 5) but rather seeking to identify when entitlement arises. In these circumstances, it would need to be clear that the specified grant period covered a period after the year end date.

Question 5: Can income be recognised in line with a funder’s stage payments?

Normally, a funder’s payment schedule should not be seen as defining when income should be recognised unless it inferred expenditure was limited to a future accounting period. Charities that recognise income in line with a funder’s payments focus on the issue of performance conditions.

A grant that is subject to performance or other conditions needs to be carefully considered. If it is received in advance of delivering the goods and services required by that condition, or is subject to other conditions wholly outside the control of the recipient charity income should not be recognised and should be accounted for as a liability and shown on the balance sheet as deferred income. Deferred income is released to income in the reporting period in which the performance or other conditions that limit recognition are met.

When income from a grant or donation has not been recognised due to the conditions applying to the gift not being wholly within the control of the recipient charity, it should be disclosed as a contingent asset if receipt of the grant or donation is probable once conditions are met.

When meeting terms or conditions are within the charity’s control and there is sufficient evidence that they have been or will be met, then the income must be recognised. Terms or conditions such as the submission of accounts or certification of expenditure are treated as administrative requirements that would not prevent the recognition of income

The default position is that income recognition is not simply to be based on when a funder makes payment. However the timing of receipts by a charity may be indicative of other persuasive factors.

The charities that, in some circumstances, recognise only the income they have received explain that the funder has not held back an element of the funding simply to manage cash flow. But rather because the funder understands the problem with grantees delivering to time, to specification and spending all the funds granted. In short the preparers of the charity’s accounts are taking the view that retention by the funder is recognition of the fact that there is uncertainty as to whether a charity and / or its partners will be able to meet the requirement of the full funding. This is often supported by cases of claw back and also the condition that not all the funding may be drawn down.

In effect, the preparers of accounts are representing that this is a case where uncertainty exists as to whether the recipient charity can meet conditions which may not be within its control. In effect, they believe that they are not able to be satisfied that there is sufficient evidence that the funder’s requirements will be met to create entitlement to the whole of the funding. his approach needs to be carefully considered and substantiated by the facts and operational realities.

6

Question 6: FRS 102 allows charities to defer the recognition grants provided for the purpose of purchasing fixed assets will the new SORP permit this?

FRS102 adopted a compromise position as an interim solution. However, this only applies to government grants. FRS102 allows such grants to be accounted for under the accruals model or the performance model.

The Charity SORP has not changed its position on this, which is principles based and allows only the performance model. Grants from Government are not to be treated in a different way from other grants. The position is the same as in SORP 2005 and the grants need to be considered to establish whether they have conditions attached which may prevent the recognition of income.

The new SORP will continue to support the principle that where a donation or grant is given specifically to provide a fixed asset or a fixed asset is donated (a gift in kind), the charity is normally entitled to that income when it is receivable. At this point, all of the income must be recognised in the Statement of Financial Activities and not deferred over the life of the asset.

Similarly, a condition that allows for the recovery by the donor of any unexpended part of a grant does not prevent recognition. Instead, a liability to any repayment is recognised when repayment becomes probable.

Question 7: At present we recognise all the grant and donation income that we have received does all the discussion above mean that we will need to change this and defer some of the income?

The simple answer is no if the grants and donations are unconditional gifts. (Note that a purpose restriction is not the same as a condition and would not itself prevent income recognition). If you are following the existing rules correctly it would mean that you are recognising the grants and donation income that you have received because they are not performance related or time restricted. The receipt of such income, even if it was purpose restricted, would imply that you have full entitlement to the income you have received and therefore it must be recognised. The probability and measurement tests are also met if the income is received. Indeed, with grants or donations there may be a need to accrue income that has not yet been received if it meets the three income recognition criteria.

The SORP explains that in the case of a grant, evidence of entitlement will usually exist when the formal offer of funding is communicated in writing to the charity. In the case of a donation, entitlement usually arises immediately on its receipt. However, the SORP also explains that both grants and donations may include terms or conditions which must be met before the charity is entitled to the resources.

In practice, trying to distinguish between a grant and a donation for accounting purposes can be confusing because nomenclature should not define the accounting treatment and the reality is that there is no real difference between a donation and a grant. This would mean that entitlement to a grant or donation would prima facie arise at the same point. Conventionally though, the view has been that entitlement is linked to the “enforceability” of the offer. In effect, charities usually recognise grant income where the grant offer is unconditional and in writing.

On the other hand a pledge from an individual donor has in practice usually not been recognised until it is received. .Having said that if a charity has evidence, usually in writing, from an individual of a pledged donation then I would be ready to consider that the entitlement test is met as the source of the income would not normally define entitlement.

7

However, the source of income may need to evaluated when considering the probability of receipt. You may believe that an unconditional grant offer from a grant making trust or institutional funder means that receipt is more likely than not (the probability test). On the other hand you may believe that a pledge from an individual may be less likely to materialise.

Question 8: What about legacy income – has the SORP changed the recognition?

Once again the first test is does the charity have entitlement. At present there are different approaches being adopted by charities on the recognition of income. With regard to entitlement there are essentially two policies being operated by charities;

i) entitlement is when probate is filed ii) entitlement is when estate accounts are settled / there is notification of a

distribution

(There is a third – where legacies are accounted for on a receipts basis. This is not seen a complying with the SORP unless the difference between received and receivable is not material.)

SORP 2005 favoured the second option. The reason for this is that when considering entitlement, although legal title to assets in an estate transfers to a legatee only when that title is actually transferred, beneficial title may transfer at another time. It is quite common for a charity to instruct the executor to sell property in an estate on their behalf - legal title may pass directly from the estate to a purchaser effectively bypassing the charity.

However the beneficial title transfers as and when the executors conclude that the particular asset will not be required to satisfy claims in the estate. The legacy may be contested or there may be significant liabilities to meet. Therefore a charity legatee would have an interest to ensure the estate was properly managed but would not have a specific interest in the property until the executors have concluded that the property will not be needed to meet other claims.

SORP 2005 recognised this distinction and explained: “It is unlikely in practice that the entitlement, certainty of receipt and measurability conditions will be satisfied before the receipt of a letter from the personal representatives advising of an intended payment or transfer. The amount which is available in the estate for distribution to the beneficiaries may not have been finalised and, even if it has, there may still be outstanding matters relating to the precise division of the amount. In these circumstances entitlement may be in doubt or it may not be possible to provide a reasonable estimate of the legacy receivable, in which case it should not be included in the Statement of Financial Activities.”

At the time of drafting the new SORP the SORP Committee did consider whether a more standardised approach might be desirable in view of the apparent diversity of treatment and potential inconsistency in the reporting of legacy income in the charity sector. The SORP Committee’s published minutes explains the reason why it was thought appropriate not to change the fundamental approach.

It was noted that there is a difference of view amongst charity legacy officers and legal advisers as to whether probate can be considered the point of entitlement. Indeed entitlement arguably actually arose from the death of the benefactor and the presence of a valid will. However other legal advisers argued that until a firm communication of a settlement or a court ruling was made no entitlement could be held to exist as a will could always be successfully contested. Whilst probate provided a useful public record of total assets and liabilities it was at best a starting point.

8

As to there being a diversity of treatment, the SORP Committee considered it appropriate that charities deal with legacies based upon their own circumstances, the availability of historical information on income from legacies and the advice that they received. The result is that whilst the SORP explains the issues there was a recognition of the need for degree of flexibility so that charities can apply their own judgement and estimation techniques whislt still falling within the rules.

Therefore SORP 2015 continues to allow the flexibility that exists in the current SORP and explains:

“For accounting purposes, evidence of entitlement to a legacy exists when the charity has sufficient evidence that a gift has been left to them and the executor is satisfied that the property in question will not be required to satisfy claims in the estate.

“Of itself, establishing entitlement is insufficient to recognise legacy income. The recognition of the gift is also affected by the probability of receipt and the ability to estimate with sufficient accuracy the amount receivable.

Receipt of a legacy must be recognised when it is probable that it will be received. Receipt is normally probable when:

there has been grant of probate; the executors have established that there are sufficient assets in the estate, after

settling any liabilities, to pay the legacy; and any conditions attached to the legacy are either within the control of the charity or have

been met.”

Some charities have sufficient information on their legacies trends to take an alternate view. I know that some charities accrue their legacies when probate is filed. This treatment can be acceptable if there is evidence to show that it does not provide a result that is shown to be materially incorrect. SORP 2015 now specifically explains the use of trends and historical information and states

“Charities which receive a significant number of legacies in a reporting period and have detailed historical information on the settlement of legacies may (my emphasis) apply an estimation technique in measuring the value of legacies that are recognised to allow for potential variation in settlement values and the risk of a will being contested. For example, where a charity has numerous immaterial legacies, by using a portfolio approach, the charity may estimate the monetary value of the income that may be received from legacies to which they are entitled by applying a formula or mathematical model. However a portfolio approach is unsuitable for material legacies or when a charity only receives legacies infrequently, as these should be considered individually. When a portfolio approach is not adopted charities must (my emphasis) recognise a legacy when the executors have determined that a payment can be made following the agreement of the estate’s accounts, or on notification by the executors that payment will be made.

In my experience most preparers of charity accounts would rather not recognise income that may not be received for a long time. So in practice charity accountants try to find a pragmatic way of deciding on which legacies should be included in the year end accounts. For example, when trying to establish entitlement date many charities review the legacies received in the first few months after their yearend to establish whether entitlement was before the year end.

9

This is based on the assumption that if executors had concluded before the year end that the funds were not needed for other claims then it would not be unreasonable to assume that the funds would be received within a few months. Those preparing the accounts look at the legacies received in post the year end and then establish when the legacy had pre or post year end entitlement.

It is important to note that these are estimation techniques and should be used as such. If there is persuasive evidence to show that they are not providing the right answers they should be reviewed. If the charity has a policy of reviewing legacies received up to two months after the year end and a material legacy was received a few days after this period it is not sufficient to say that the policy requires a cut off at two months – it would be necessary to include the legacy if there was evidence to show that entitlement existed before the year end.

If you are changing the way you recognise legacy income you need to consider carefully if this is a change of accounting policy that requires a prior year adjustment or whether it is a change of accounting estimate.Adjusting for changes in accounting estimates and estimation techniques results in a change to the transaction value or carrying amount of the asset or liability in the current reporting period; no adjustment is to be made in respect of prior reporting periods.

Some charities treat pecuniary and residuary legacies in a different way. This is on the basis that with a pecuniary legacy that is of a size that it is apparent from the notification or probate that the fixed amount will be paid then it would not be unreasonable to treat the legacy as receivable before formal communication is received that it is to be paid.

Note that the SORP continues to require disclosure of the pipe line of legacies that have not been accrued.

Question 8: What about gifts in kind

This is an area that caused quite a lot of concern at the Exposure Draft stage of FRS102. In fact although there has been a change in requirements it is unlikely that there will be a material impact for most charities.

The accounting treatment differs for the type of gifts.

Gifts for resale – this would usually be through charity shops and FRS102 has raised the stakes on this. Previously charities recognised the income when the donations were sold FRS102 requires that income should be recognised once the items for resale have been received. However after a strong lobby for the charity sector practicality considerations have been included in the standard and the SORP explains that although goods donated for sale are normally recognised at the point of receipt, practicability may dictate that they are recognised only on their sale.

Before undertaking a the task of measuring and valuing donated goods which are unsold the charity should consider the materiality of the donations received and whether the cost involved in undertaking a valuation is justified by the benefits. The SORP refers to benefits of the users of the accounts in terms of their better understanding the resources available to the charity and to the charity itself from having this financial information. In practice I believe that this will mean that goods for resale through charity shops will continue to be recognised when sold.

10

Gifts for onward distribution - The rules for when these goods should be recognised are similar to good for resale and similar practicality tests will apply. They should normally be recognised at fair value. However the SORP explains that it may be necessary when valuing the donation to consider any restriction on the sale of the asset or the factors that may reduce the fair value of the asset.

Factors to consider include proximity to a product expiry date or the availability of lower-cost substitutes for the donated item, for example a generic version of a drug. Donated goods held in stock for distribution must be assessed for impairment at the reporting date

Donated facilities and services – The SORP explains that facilities such as office accommodation or services supplied by an individual or an entity as part of their trade or profession can usually be reasonably quantified and must be included in a charity’s accounts. Donated facilities and services are therefore measured and included in accounts on the basis of the value of the gift to the charity. The services of general volunteers are not recognised as income. This is based on practical considerations rather than a principles based approach,

In conclusion:

Preparers and auditors of charity accounts need to carefully consider the substance of the transaction. I see cases of charities believing that the SORP requirements are forcing them to account for income in a way that seems to be counter intuitive to their understanding of the donor / funder’s expectations. In many cases the funding agreement / contract or other documentation does not help with considering income recognition. To deal with this many charities have started obtaining supporting documentation from the donor / funder to support the income recognition treatment they are using. Where charities want to establish some linkage to recognise grants, for example, in a particular year or in relation to particular expenditure it should be clear through the supporting documentation that this is what the funder requires/desires. The documentation which can be in correspondence that is additional to the grant agreement should clarify that the funder’s intention was / is that entitlement to the income is in the way that the charity is proposing to recognise the income.

This is a complicated area and care needs to be taken to ensure that the accounting treatment reflects the operational realities and the nature of the funding agreements. Contrary to popular misconception there is opportunity for reflecting all or any of the options discussed above so long as the criteria in the SORP are met.

Preparers and auditors of accounts need to recognise the options that are available and discuss appropriate treatments at an early stage.

© Pesh Framjee

July 2014

Pesh Framjee is head of the Not for Profit team at Crowe Clark Whitehill LLP, the lead provider of audit and related services to charities in the UK. He is Special Advisor to the Charity Finance Group (CFG). He is also a member of the Charity SORP Committee

This guidance is written in general terms and is not intended to be comprehensive. No responsibility attaches to the author or the firm and before taking any decisions on the basis of the suggestions and indications given in this paper you should consult your professional advisers.

Crowe Clark Whitehill provides guidance notes, free seminars and other material of relevance to non profit organisation. To access this and to be put on our mailing list see www.crowecw.co.uk

Payment by Results

OSSIG meeting 16 July 2014

Key Points

• DFID’s new strategy makes PBR the norm

• Both DFID and INGOs need to learn fast

• The sector will benefit more if we lead on developing and sharing learning - rather than following or even resisting DFID.

• Much has been learned in the UK sector already, which we can draw on.

What is PBR?

• PBR is a form of financing that makes payments contingent on the results achieved.

• Two types have been piloted in international development – Results Based Aid (RBA) and Results Based Financing (RBF).

• Being applied across UK Government, and also by the World Bank and USAID.

Why is PBR increasing?

• The UK Govt’s rationale for PBR is to encourage competition and innovation and a more outcome orientated approach

• However, there is growing evidence that the approach can lead to a market contraction and a risk averse culture rather than innovation.

• Much depends upon the proportion of the contract subject to PBR

DFID’s New PBR Strategy

Source: DFIDD

How DFID thinks PBR affects VfM

Source: DFIDD

Key Issues – Risk and financing

Issue Key considerations

Pre-financing PBR and other contracts usually require the

service provider to pre-finance the cost of

inputs to achieve the results.

Indemnities,

guarantees

and liability

clauses

Most commercial contracts require providers

to take out professional indemnity insurance.

Many donor contracts seek to have very

wide-ranging indemnity and liability clauses

making the provider liable for everything,

even if they have not been negligent.

Key Issues – Negotiate hard

Issue Key considerations

Highly

specified PBR

contracts

Experience to date suggests that DFID will be

highly prescriptive in how services are

specified. Concerns over transparency mean

that DFID may still require detailed financial

reporting, in contrast to how PBR has been

implemented in the UK.

Consortia

working and

sub-

contracting

DFID is encouraging non-exclusivity. There is

no requirement for INGOs to accept a flow-

down of the contract, or to accept similar

risks, pre-financing or PBR.

Models of PBR

Issue Key considerations

Binary

payment

Payment is achieved only on absolute

completion of the target. It is a ‘yes/no’

against the measure of success.

Frequency

payment

Payments are made for percentages of target

population who achieve outcomes. This is a

stepped model, which is often capped – the

more results you get, the more you are paid.

Level of PBR It appears that good practice in the UK is for

PBR not to exceed 20% of contract value

Source: NCVOD

1

June 2014

Sharpening incentives to perform:

DFID’s Strategy for Payment by Results

2

Contents

Contents 2

Foreword 3

1. Rationale & Scope 4

A strategy for Payment by Results 4

What is Payment by Results? 4

Why Payment by Results? 9

What does the evidence say? 10

2. What have we done so far? 12

DFID’s current activities 12

Moving towards payment by outcomes 14

Building an enabling environment for Payment by Results 15

3. What more will we do? 17

DFID's Objectives for Payment by Results 17

We will expand the evidence base 18

We will build capabilities for doing Payment by Results the right way 19

3

Foreword

Since becoming International Development Secretary I’ve been determined to ensure that every pound we spend has the biggest possible impact on the ground. I have brought in new financial controls to give ministers more oversight of spending decisions and greater transparency so the taxpayer can see exactly where their money is being spent. DFID is also becoming a world leader in pioneering innovative Payments by Results programmes for tackling complex development problems.

We are pioneers of ‘Results Based Aid’ which incentivises partner governments to demonstrably transform peoples’ lives. Already our Payment by Results programmes are helping more children to stay in school, more women to give birth safely with the help of a skilled attendant and more people to have access to water.

As this strategy sets out, we are determined to take this approach further. DFID recently launched the inception phase for one of the world’s first Development Impact Bonds to invest in preventing the deadly but neglected sleeping sickness in Uganda, which passes from cattle to people. This project will bring together private and public investment to fund schemes that will treat infected cattle before the disease spreads and investors will earn a return if the programme is a success.

I want Payment by Results to be a major part of the way DFID works in the future. We will develop a framework to ensure that for all of our Payment by Results projects, there are rigorous, independent, comparable evaluations in place, so we can learn more about what works best, in what circumstances. We are committing to making those evaluations public, so that others can learn from them too.

As we scale up our use of Payment by Results, it is clear we will require a particular set of skills and capabilities within DFID. This strategy also outlines our plans for reshaping the Department and ensuring we are properly equipped to make the most out of Payment by Results. This will include reforming our funding systems to make Payment by Results easier to administer.

If we can get this right then Payment by Results will help us to make our development budget go much further, bring more people out of poverty for good and ensure we a getting the greatest value for money on behalf of the British taxpayer.

Justine Greening, Secretary of State for International Development

4

1. Rationale & Scope

A strategy for Payment by Results

1.1 DFID is increasingly making use of Payment by Results. As the number of programmes

grows, DFID needs a consistent approach and a clear way forward. This strategy sets out our

objectives for the use of Payment by Results and the actions we will take to achieve these. Section

1 outlines the background to Payment by Results: what DFID means by the term; why we use it;

what we know already; and where the gaps in our knowledge lie. Section 2 sets out what DFID is

already doing on Payment by Results, in terms of programmes and corporate systems of support.

Section 3 establishes DFID’s objectives for Payment by Results and gives an overview of the

actions we will take to achieve them.

What is Payment by Results?

Payment by Results can be applied in different ways in different circumstances

1.2 There is no common international definition of Payment by Results. In DFID, we include

any programme where payments are made after the achievement of pre-agreed results, rather than

being made up front to fund future activities. This means sharing more risk for delivering results

with those who are implementing development programmes, for example contractors or partner

governments.1 Within that broad definition there are many different types of Payment by Results

programme.

1.3 Payment by Results can be designed in different ways to get best value for money. DFID

wants to find the best ways to design and deliver Payment by Results, and will continue to adapt

our guidance on best practice as evidence and learning grows. There are three main design

choices:

1 Even when 100% of payments are made on delivery, DFID will retain some risks, for example, reputational.

5

The level of payments on delivery (or extent of risk sharing): the proportion of payments

made once pre-agreed results are achieved, from 100% on delivery, to only a small amount,

with the majority up-front. A key question to consider is the extent to which the implementing

organisation is able to manage the additional risk of Payment by Results. A large

organisation with strong systems may be able to hold more risk, but a small organisation

that is less able to absorb risk may require a significant upfront payment, with only a small

proportion of payment on delivery. Another way of getting more money up front to

implementers who are less able to manage risk while still paying on results could be a

Development Impact Bond (see Box 1). In this arrangement, the risk is shared with

investors, who put money into a development intervention and are repaid (by a funder such

as DFID) based upon results achieved.2

The type of organisation

(partner government, supplier

or investor) payments are

made to. A key question to

consider here is the level of

influence the relevant

organisations have over the

results in question. The more

influence organisations have on

results delivery, the greater the

potential to base payments on

their achievement.

The type of result that the payment is linked to (see Figure 1 for more detail on the

results chain): A key question here is the scope for flexibility and innovation in delivering the

intended results. The more open a problem is to innovation and flexibility, and the broader

the sphere of influence the type of organisation has, the more scope there is for Payment by

Results to be applied higher up the results chain (linked to outcomes not processes). A

practical question will be on the type of result that can be measured, for example, what

indicators are routinely measured already?

2 See the CGD and Social Finance co-chaired working group on this issue: http://www.cgdev.org/section/about/cgd_europe/development_impact_bonds.

Box 1: DFID terminology for different types of

Payment by Results

DFID differentiates Payment by Results by the type of

organisation payments are made to as different approaches

are needed with different organisations:

Payments from funders to partner governments are

categorised as Results Based Aid.

Payments from funders or government to service

providers are classed as Results Based Financing.

A newly emerging form is Development Impact Bonds

where investors are paid for delivery of results.

6

1.4 A further design choice is around the kind of capacity development (technical support or

training) that is needed to ensure that the programme can deliver the results in question. For

example, should support be focused on performance management, technical capacity building or

on strengthening data systems?

1.5 DFID does not stipulate the type of organisation we work with or a minimum amount of payment on delivery, but an intervention will only be regarded as Payment by Results if payments are made for pre-agreed results, rather than inputs. Development is a complex

process and what constitutes a “result” will vary according to context. To count as Payment by

Results, payments have to be for measurable improvements in performance. The results chain

is illustrated in Figure 1 below, using examples from the education sector.

Figure 1: The results chain

7

Box 2: Designing Payment by Results in Practice in Rwanda and Uganda

Different kinds of support in different countries3

DFID continues to learn about the best way to make Payment by Results work in different circumstances. For

example, in theory the fact we don’t specify how results are to be achieved incentivises increased ownership and

flexibility for implementing organisations. In practice, however, implementers may initially lack planning and

management experience, or confidence to steer decisions. Therefore, patience and technical assistance may be

needed. Lessons learnt below are taken from early stages of evaluations. These pilots are still being implemented

and evaluations will fully assess impact.

Rwanda

In a Payment by Results

programme in Rwanda, DFID

emphasised the importance

of recipient discretion,

without targeted technical

support.

The Government’s response

to the Results Based Aid (RBA)

agreement was very positive,

with strong messages sent

down through the system

regarding the results to be

achieved. Though it is too

early to expect significant

evidence of impact, early

indications from the

evaluation are that RBA has a

high level of government

ownership and has prompted

the strengthening of this

message.

Education Results Based Aid in Rwanda

Health Results Based Financing Uganda

Results

Improved completion of

education, measured by

sitting key grade exams.

Improvements to key maternal and

child health indicators.

Risk

100% paid on delivery of

results, a component of a

mixed-modality education

disbursed as Sector Budget

Support.

Essential medicines and small seed

grants paid up front.

Who gets paid?

Government of Rwanda,

Ministry of Education. Individual health facilities.

Technical Assistance (TA)

No initial TA given –

recipient discretion

emphasised.

TA to business planning, financial

management, supply of drugs, and

District Health Teams for

independent monitoring of services.

Uganda

In Northern Uganda, DFID is running a Results Based Financing (RBF) health programme. Significant support was

given upfront in terms of planning, seed money and financial management, as the capacity of the service

providers was judged to require it. Early indications from evaluations are that the RBF has been associated with

improved treatment practice, higher customer satisfaction, and improved value for money.

3 Information is taken from Northern Uganda Health (to be published later in 2014) Lessons Learnt Paper and Upper Quartile (2014) Evaluation of Results Based Aid in Rwandan Education: 2013 Evaluation Report.

8

Payment by Results won’t always be the best instrument to get best value for money

1.6 There are key questions to ask when working out whether a particular programme is suitable for Payment by Results. For example, if a results indicator can’t be identified and

measured, or if verifying it is too costly, a different way of providing development assistance may

be preferable. Early experience indicates that when considering if Payment by Results is the best

mechanism to get value for money, two questions are key:

Does the programme need an improvement in overall performance that could be helped by a strengthening of incentives?4 Considerations include:

o What is holding back the achievement of development results?

o What can overcome these constraints? Would targeting specific actions unblock

them? In which case it may be more appropriate to pay for actions not results.

Alternatively, would access to finance or technology provide the solution?

o For Payment by Results, implementation challenges will be predominantly

institutional, with improved overall performance requiring a stronger focus on

incentives and accountability for results.

Are the potential benefits from using Payment by Results likely to outweigh the costs,

relative to other mechanisms?5 Considerations include:

o Whether existing systems and capacity are sufficient to apply and monitor Payment

by Results. Will the recipient be able to fund activity upfront, monitor results achieved

and respond/ reallocate resources to increase results? Can these issues be solved by

targeted upfront finance or technical assistance? If not, Payment by Results may not

be appropriate.

o What are the probable costs of design, verifying results achieved, contract oversight,

risk sharing, and any technical assistance?

o What are the probable benefits that can be realised from incentive payments, such as

improved results, stronger management or data systems?

4 World Bank (2013) A new instrument for Development Effectiveness: Program-for-Results Financing. 5 Clist P (2014) The Conceptual Basis of Payment by Results.

9

1.7 You can’t answer these questions without also considering how the programme would be designed, as outlined above. What results can be measured? What proportion of payments

should be linked to delivery? What is the right type of organisation to work with and what level of

control do they have over the results in question? What are the implications of these choices for

costs and benefits?

Why Payment by Results?

Payment by Results offers an opportunity for DFID to transform the delivery of

development assistance by paying once results are achieved

1.8 DFID’s move towards Payment by Results is part of broader reform to make sure we get good value for money from the development budget, including stronger programme and

commercial management. By paying on delivery of outcomes, Payment by Results can be used to

directly drive DFID’s priority results, such as economic development, empowerment and

accountability, and improved outcomes for women and girls.

1.9 Payment by Results is part of cross government reform, and several other government

departments are using Payment by Results to transform the delivery of public services.6

1.10 Payment by Results is also starting to gain momentum in international development, with DFID one of the leaders in the field.7 Several aid organisations are starting to pilot or scale up

the approach, with organisations such as the World Bank using exciting new Payment by Results

approaches including the Program-for-Results, where governments are paid on the delivery of

results and the Health Results and Innovation Trust Fund, where service providers are paid on the

improvement of key health results. The Centre for Global Development has been a thought leader

with its comprehensive work on “Cash on Delivery”, and more recently Development Impact Bonds.

1.11 By paying on delivery of real results rather than upfront, Payment by Results helps DFID to improve value for money for citizens of the UK and developing countries. Payment

by Results can be used to:

6 Payment by Results is strongly referenced in the Cabinet Office’s Open Public Services White Paper, and Open Public Services 2012 Update, which set out the Government’s priorities for civil service reform. 7 See, for example, Performance Based Financing An international review of the literature, Canavan et al. (KIT Development Policy & Practice, 2008).

10

Re-balance accountability. In traditional aid, by paying upfront DFID accepts the bulk of

the risk of programme failure. Payment by Results redresses this balance by sharing the risk

for delivery with partners. This sharpens incentives for implementers to perform.

Increase innovation and flexibility in delivery. By not specifying how results should be

achieved, implementing organisations are free to innovate to improve outcomes.

Increase transparency and accountability for results. Through being open about agreed

results, everyone is clearer about what is being targeted and whether it actually gets done,

driving up empowerment and accountability for results.

Create a strong focus on performance in service providers. By being paid on results,

partners are strongly encouraged to examine what is, and isn’t, working, driving up

performance standards, management and measurement.

What does the evidence say?

1.12 Evidence about how Payment by Results can be most effective is still at an early stage. This is primarily because these are relatively new mechanisms and to date there have been few

good evaluations of those programmes that have been in place.8 This is particularly true for more

innovative mechanisms, where payments are linked to outcomes. In addition, the majority of past

activities and evaluations have been in the health sector and related to payments to suppliers

(Results Based Financing) rather than to partner governments (Results Based Aid) or investors

(Development Impact Bonds). There are early indications that in the right circumstances Payment

by Results can lead to better delivery of services.9 A DFID sponsored report, published in 2013,

synthesised findings from Payment by Results evaluations to date and concluded that we need to

develop better evidence about when and how these incentives work in practice.10

1.13 To build the evidence base and learn how to apply Payment by Results well, DFID’s strategy will focus on expanding the scope and use of the mechanism and ensuring robust

8 Evaluation of Payment by Results: Current Approaches, Future Needs, Burt Perrin (DFID, 2013). https://www.gov.uk/government/publications/evaluation-of-payment-by-results-current-approaches-future-needs p, 20, 25. 9 Meesen et al (WHO, 2010) Performance-based financing: just a donor fad or a catalyst towards comprehensive

health-care reform? http://www.who.int/bulletin/volumes/89/2/10-077339/en. 10 Perrin, op cit.

11

and well-designed evaluations are in place. Evaluations will be prioritised in those areas where

evidence is most lacking, and in a way that brings together learning from across activities. We will

also make use of evidence generated by others, including partners in the UK and those working

internationally.

Box 3: Early lessons: Improving performance in Rwanda and Uganda

The examples above provide some early indications of the benefits of Payment by Results in practice.

Improving results data

In Uganda, local government teams check the results data for consistency prior to payment. This has led to early

indications of a reduction in discrepancy rates between reported and verified data.

Strengthening empowerment and accountability

In Rwanda, every year, the Rwandan media publishes league tables on the number of children passing exams in

each district. This year, the media also reported the percentage that sat exams out of those that registered to do

so, encouraging a public debate around the causes of drop out and school completion.

A strong focus on performance & efficiency

There is also early evidence of implementing organisations using results information to focus effort and resources

where they are needed most. In Rwanda the Director General of the Rwanda Education Board said that he could

use it to push his team to achieve more and better results by using data to identify where further improvements

in results could be made. In Uganda, there are early indications that the tool is leading to more efficient use of

resources and better value for money.

12

2. What have we done so far?

DFID’s current activities

DFID uses Payment by Results widely and increasingly across its operations

2.1 Payment by Results is already a core part of DFID’s work. DFID is increasingly using

Payment by Results by default, wherever it offers best value for money. In the 12 months to end

September 2013, 71 per cent of contracts for services issued centrally by DFID have a

performance-based element, where payment is conditional on verification of a result being

achieved. DFID is moving towards using more innovative forms of Payment by Results in our

contracts. For example, we are increasingly using contracts where payments are made on the

delivery of longer-term results (‘output-based contracts’).

2.2 DFID’s provision of general budget support is reducing, and where financial assistance is provided to governments, most programmes use performance tranches, attaching a

proportion of funds to indicators in monitoring frameworks. These indicators are situated at various

points in the results chain (see Figure 2), including at outcome level. For example, DFID provides

up to £15 million of funding directly to the Government of Sierra Leone’s budget. £5m of this is

based on the Government’s performance against a set of around 20 mutually agreed targets

tracking progress in specific reforms and development outcomes linked to the country’s

development strategy.

2.3 The use of these performance tranches has been increasing over the past few years, and continues to increase. Roughly one third of general budget support funds are already tied to

performance. Our work with governments also includes Results Based Aid, one of the most

innovative forms of Payment by Results, where payments are linked to outcomes such as improved

completion in education, encouraging governments to deliver more results in the most pressing

areas. A strong pipeline of potential new Results Based Aid programmes is developing, in sectors

such as health, infrastructure, and water and sanitation.

2.4 We use Payment by Results in our contribution to global funds. As global funds are able

to innovate in a way that other organisations can struggle with, we are funding some global funds

13

to push the boundaries of Payment by Results, exploring payment by outcomes in areas like

health, infrastructure and education. One example is explored below in Box 4.

2.5 We are using Payment by Results in our funding to civil society organisations (CSOs). For example, the Girls Education Challenge Fund (GEC), which is helping up to a million girls

transform their lives through education, uses Payment by Results extensively across its

programmes: currently 25 out of 37 projects have a Payment by Results component, many of

which are CSO implemented, with others being run by private sector contractors.

2.6 Payment by Results is supporting delivery of DFID’s priority objectives, for example on

women and girls, economic development and generating feedback from beneficiaries. DFID is

working with the Government of Sierra Leone to develop a Gender Tracking Tool, and a Portal

which will track progress on delivery for women and girls. We will also help capitalise the Ministry of

Finance’s “Women and Youth Empowerment Fund”, which will be used to reward line ministries for

delivering pre-agreed results for women and girls, like increasing the percentage of women

Box 4: Case Study: The Health Results Innovation Trust

What are we doing?

The Health Results Innovation Trust Fund (HRITF) is a World Bank

hosted trust fund supported by DFID and the Norwegian Agency for

Development Cooperation, with a total value of $530m over 10 years.

It pilots and evaluates the ability of Payment by Results approaches in

the health sector to increase the quantity and quality of child and

maternal health services. HRITF currently supports 32 pilot grants in

countries, impact evaluations of these, and smaller learning and

evaluation programmes in non-pilot countries. HRITF has significant

overlap with DFID priority countries and is funding programmes in 14

of these. A further three programmes are in the pipeline.

Building evidence

HRITF is producing evidence about results-based financing approaches

which DFID and others can draw on to inform our own programming.

Assessments, case studies, papers, and evaluations (plus an impact

evaluation toolkit) can all be found at . www.rbfhealth.org

Is it working?

Early results are now available for

11 grants, with data showing

initially positive results. For example

between 2010 and 2012:

1. The number of deliveries with

skilled birth attendants supported

by HRITF grants in two countries

(Afghanistan and Burundi) increased

83% from 190,000 to 347,130.

2. The number of children fully

vaccinated with program’s support

increased 67% from 281,200 to

469,600.

14

accessing micro-credit and reducing gender based violence. These will be measured through the

Tracking Tool. Work is currently ongoing to determine which results will be measured. Through

local grassroots organisations, beneficiaries will have a role in rating the ministries through a

scorecard on the Web Portal, which will help determine the levels of payment to those ministries.

Moving towards payment by outcomes

Box 5: Case study: Development Impact Bond (DIB), Sleeping Sickness, Uganda

What problem are we trying to solve?

Sleeping sickness is a parasitic infection which attacks the central nervous system and can prove fatal. It is

estimated that 9 million are at risk in Uganda (and over 60 million in sub-Saharan Africa). Drugs and insecticides

have been shown to be an effective control. Historically the key challenge has been the sustainable delivery of this

control.

How are we trying to solve it?

The Development Impact Bond could offer DFID a more flexible

contracting structure: implementers could choose how they deliver the

treatment.

DFID will fund the pre-implementation phase (baselining, piloting and

setting of output and outcome targets). The bond could then be offered

to the market if it offers value for money. Social investors would be

approached with a detailed proposal inviting them to fund the delivery

of the programme.

DFID would make repayments on the basis of an independent

verification of outputs and outcomes (see opposite). The total

payment/return to social investors would be dependent on the outputs/

outcomes achieved. If the outcomes are not achieved the investors

would make a significant loss, but if it is achieved, they would make a

modest return.

How will we evaluate what we’ve done?

As Development Impact Bonds are so new, it is particularly important to get evaluation right. We are therefore

commissioning a study to identify the most appropriate evaluation approaches and methods.

Delivery Channel: Private sector

veterinary practices.

Metrics: number of cattle treated

(output); reduction in prevalence of

parasite determined by blood

sampling (outcome).

Timeline: We have started the

inception phase (2014). This will be

followed by presentations to

investors and contracting.

Programme implementation could

take place in early 2015.

15

DFID is focused on increasing the use of the most promising forms of Payment by Results –

where payments are made for outcomes

2.7 The most innovative kind of Payment by Results links payments to outcomes (although

outputs are often used as proxy indicators – see Figure 2 for more information on how outputs

differ from outcomes). DFID is at the forefront of global efforts to build the evidence base for this

kind of Payment by Results in international development. As of June 2014 there were 21

outcomes-based programmes that use DFID financing underway, including seven funds which

constitute around 100 separate projects.11 These involve working with governments and suppliers

to deliver a wide range of outcomes, from children completing education, to safe deliveries for

women, and to families having access to water points.

2.8 There are also at least 17 more outcome-based Payment by Results programmes still at

the planning stage. These are in a wide variety of different countries and sectors. They are at

various stages of development. Programmes or scoping work have been proposed across all

sectors of DFID’s work; and across all types of Payment by Results, including for two Development

Impact Bonds.

2.9 For our most innovative Payment by Results projects, we have independent evaluations in place, which are investigating both results achieved and the processes used to achieve them.

Building an enabling environment for Payment by Results

Understanding the factors that will help Payment by Results to flourish in DFID

2.10 DFID’s experience to date has taught us that doing Payment by Results well requires upfront investment of time and effort.

2.11 DFID is building up Payment by Results relevant skills and changing systems through

the following measures:

Increasing our skills and capabilities. We are addressing our skill needs in line with UK

Government Civil Service Reform, with emphasis on commercial capabilities, finance, and

technical competencies.

11 As tracked by DFID departments and countries.

16

Networking and knowledge sharing: DFID has set up a Payment by Results community of

practice to encourage learning and innovation. This network meets regularly to share

knowledge and best practice. External experts such as the Centre for Global Development

and Social Finance attend regularly. We also share knowledge with other government

departments using Payment by Results in the UK.

Guidance and support. DFID’s central departments offer support and advice where

requested, with central guidance available.

Financial planning for Payment by Results programmes can be more challenging due to

the inherent uncertainty of the results the implementing organisation will be able to deliver

(and hence the overall costs of the program). At present DFID departments are required to

manage this uncertainty within their overall programme budget. This is a challenge common

to Payment by Results in all sectors, domestically as well as internationally, and cross-

government discussions are on-going about whether and how to update budgeting systems

to take account of it, and whether alternative approaches to managing uncertainty in costs

could work better.

17

3. What more will we do?

DFID's Objectives for Payment by Results

Using Payment by Results to improve the value for money of our development

interventions through sharpening incentives to perform

3.1 The objectives of DFID’s Payment by Results work are to:

Expand the evidence base on what works best.

o Expanding the scope of Payment by Results in the right areas to strategically address

evidence gaps.

o Establishing rigorous, independent, and comparable evaluations of Payment by

Results.

o Influencing and learning from others working on Payment by Results both

domestically and internationally.

Build capabilities for doing Payment by Results in the right ways.

o Translating evidence into action across DFID.

o Addressing systematic and incentive changes required to expand the scope of

Payment by Results, focusing on leadership, resourcing, culture and behaviour

change management, and commercial improvement.

o Building skills and competencies relevant to Payment by Results, in our partners and

DFID.

18

We will expand the evidence base

We will continue to expand the scope of Payment by Results where appropriate, with a

view to strategically addressing evidence gaps

3.2 Payment by Results is already an important part of how we do business and ensure value for money. This provides us with a solid starting point for expansion into new areas. We will

focus on the following areas because they address gaps in the domestic and international body of

evidence about how, when and where Payment by Results works most effectively.

We will:

Use Payment by Results instruments in new sectors. For example, we are planning

projects in agriculture and private sector development, and we will explore whether and how

Payment by Results might be appropriate in humanitarian programmes.

Use new types of Payment by Results instruments, for example, Development Impact

Bonds (see Box 5 and Figure 1 for more details).

Make Payment by Results our ‘business as usual’ approach in our contracts with suppliers rather than the exception.

Provide specialist funds to get the money and support to the front line to help deliver the most innovative forms of Payment by Results. For example, a ‘concept fund’ to help

grow the market on Development Impact Bonds.

Rigorous, independent and comparable evaluations, in order to learn what works

3.3 We will strengthen our support and direction of evaluations, with special attention devoted

to the most innovative projects. We will start by scoping out the options for making central

resources available for learning and evidence-building, and by commissioning a study on the best

ways to evaluate Development Impact Bonds.

3.4 We will provide a framework for Payment by Results evaluations to ensure a strategic and

consistent approach. We will synthesise the results of these evaluations, and integrate our findings

with evidence from other organisations. Value for money will be our primary focus throughout.

19

Leading by example, influence, link with and learn from others applying Payment by

Results both domestically and internationally

3.5 We will remain at the forefront of international work on Payment by Results, focused on

the most innovative kinds of projects, where most gains are to be had in influencing our partners.

We will work closely with our partners to ensure we grow the evidence base together, and learn

from each other’s experience. For example, we will engage closely with the World Bank’s review of

Program-for-Results, integrating relevant findings into our own work.

3.6 We will continue to make the most of formal and informal networks within DFID, across

UK government and across the world to build the evidence base, share knowledge and promote

best practice.

3.7 We will adhere to best practice on transparency, taking into account the principles

underpinning UK civil service reform and emerging international standards on transparency. In

particular, we will ensure relevant guidance, project documentation and evaluation lessons are

published openly for all who would benefit from them.

We will build capabilities for doing Payment by Results the right way

Translate evidence into action across the organisation

3.8 DFID has detailed guidance on how to do Payment by Results. We will update this

regularly with lessons learnt as a result of our continuing work to build the evidence base on

Payment by Results. We will ensure that the guidance is accessible to all who need it. For

example, we will produce tools like a ‘quick start’ guide to Payment by Results and refine our

checklist of criteria for what makes a programme suitable for Payment by Results.

3.9 We will also use our internal and external networks to build and share experiences,

evidence and expertise.

Address systematic and incentive changes required to expand the scope of Payment by

Results in DFID processes

3.10 We will ensure our funding and management systems are better suited to managing and financing Payment by Results.

20

We will scope ways of improving financial planning when using Payment by Results mechanisms, to help manage the uncertainty around Payment by Results costs.

We will ensure our information management systems are set up to gather appropriate information on Payment by Results.

3.11 Payment by Results has the potential to transform every part of DFID, and so we will continue with our extensive two-way internal engagement. We will communicate throughout

our departments and country offices, and seek further input on what we need to do to make

successful the strategy outlined here. We will steer and obtain buy-in from corporate, policy and

regional divisions to drive cultural change. And we will continue to further develop Payment by

Results approaches with implementing organisations, including scoping out use of the mechanism

with other government departments where appropriate.

Box 6: Strengthening our commercial approach to Payment by Results

We will improve our commercial approach through:

Introducing and implementing a new contract model to link all payments to measurable outputs where this is identified as a best Value for Money delivery route.

Ensuring the design of programmes includes consideration of PbR options in order to plan how delivery will be achieved.

Including commercial aspects of Payment by Results in commercial and procurement training courses and events, including integrating training into Programme Management accreditation.

Capturing lessons learnt and disseminating areas for improvement to programme teams.

Providing support on commercial aspects of Payment by Results through DFID’s Commercial Adviser network and dedicated support provided by the central procurement and Commercial Department to country/programme teams.

Building a case study library of best commercial practice for Payment by Results and key commercial considerations as well as undertaking regular reviews/evaluations to feed lesson learning.

Increasing knowledge and awareness of commercial aspects of Development Impact Bonds in collaboration with other government departments and the private sector.

Continue to engage with DFID’s main contracted supplier group on the implications for them of output based contracts.

21

Building Payment by Results-relevant skills and competencies, in our partners and in DFID

3.12 We will provide formal and informal training, guidance, and networks for sharing expertise,

in order to ensure DFID staff have the skills, capability and confidence to deliver Payment by

Results effectively. We will scope out the options for providing technical assistance to DFID teams

(and where appropriate, other partners) delivering the most innovative forms of Payment by

Results, as outlined above.

3.13 We will continue to support partner governments in developing the skills and capabilities

they need to negotiate agreements, deliver results successfully, and strengthen data systems that

allow results to be rigorously verified.

3.14 We will work with global funds to share learning on Payment by Results and, where

appropriate, use our influence to increase its use.

3.15 We will also work with suppliers and other implementing organisations, including private sector organisations, civil society organisations and NGOs to help them understand

the advantages of the Payment by Results approach, and identify any development or change

management needs they have in order to successfully bid for and complete Payment by Results

contracts. At the most innovative end of Payment by Results, we will provide funding and specialist

support to grow the market on Development Impact Bonds, so that more competitive tendering will

help us get the greatest possible value for money.

22

The Department for International Development: leading the UK government’s fight against world poverty. Department for International Development 22 Whitehall London SW1A 2EG, UK and at: Abercrombie House Eaglesham Road, East Kilbride Glasgow G75 8EA, UK Tel: +44 (0)20 7023 0000 Fax: +44 (0)20 7023 0016 Website: www.dfid.gov.uk Facebook: www.facebook.com/ukdfid Twitter: @DFID_UK Email: enquiry@dfid.gov.uk Public enquiry point: 0845 3004100 or +44 1355 84 3132 (if you are calling from abroad) © Crown copyright 2014 Copyright in the typographical arrangement and design rests with the Crown. This publication (excluding the logo) may be reproduced free of charge in any format or medium, provided that it is reproduced accurately and not used in a misleading context. The material must be acknowledged as Crown copyright with the title and source of the publication specified. Cover image © Russell Watkins/Department for International Development Published by the Department for International Development, June 2014