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  • ASSIGNMENT COVER PAGESURNAME: Brinkmann INITIALS: ASTUDENT NUMBER: 17573602TELEPHONE NUMBER: 0828900663PROGRAMME NAME: EDP 2012MODULE: Financial StrategiesFACILITATOR: Prof Dave FlynnDUE DATE: 25 September 2012NUMBER OF PAGES: 39CERTIFICATIONI certify the content of the assignment to be my own and original work and that all sources have beenaccurately reported and acknowledged, and that this document has not previously been submitted inits entirety or in part at any educational establishment._________________________SIGNATUREOR6701130018085_________________________ID number for assignments submitted via e-mail FOR OFFICE USE DATE RECEIVED:
  • TABLE OF CONTENT 1. Executive Summary 1.1 Agreement, Implications and Considerations 1.2 Decisions Required 1.3 Acknowledgements 2. Problem Statement 3. Objectives 4. Methodology and Approach 5. Existing Financial Strategy, Procurement Policy and Operational Realities: WCDOH 6. Finance Strategy and Procurement Policy Alternatives and Opportunities: Discussion 6.1 Zero-based and Activity-based Budgeting 6.2 Finance Decisions and Optimal Capital Structure 6.2.1 Gearing or Leverage 6.2.2 Financial Instruments 6.2.3 Establishing the full value of assets 6.3 Upfront purchase of Maintenance Contracts 6.4 Green Procurement 7. Operating Lease 7.1 General Advantages of an Operating Lease 7.2 Key Benefits of Operating Leasing to WCDOH 7.2.1 Financial Evaluation and Benefits of Operating Leasing 7.2.2 Proposed Structure of Operating Leasing Agreements 7.2.3 Cost Reductions, Benefits, Savings: Accruing to WCDOH 8. Conclusions 9. Recommendations 10. References 11. Glossary of Terms and Annexures3|Page
  • 1. EXECUTIVE SUMMARY This document summarises the potential risks and rewards to the WCDOH, of procuring high- value assets by using operating leases instead of by way of once-off cash procurement as is currently standard policy. Alternative finance strategies and procurement policy is proposed for consideration, including the incorporation of Green Procurement policy. Operating leasing is situated within the context of the range of provincial objectives and includes considerations of Extended Producer Responsibility, Life-cycle costing and usage analysis and eventual disposal management. The report furthermore deals with Corporate Social Investment [CSI], Triple Bottom Line strategic partnerships as an extension to this procurement option and the potential added value that could accrue to the WCDOH, its employees and patients, over time. 1.1 Agreements, implications and considerations 1.1.1 An asset/equipment backlog exists generally within the WCDOH, but specifically at the three [3] Tertiary, Central Hospitals: Groote Schuur Hospital, Tygerberg Hospital and Red Cross Hospital. 1.1.2 Some, or all, of the facilities managed by the WCDOH have a shortage of equipment and/or ageing or obsolete equipment that need to be upgraded or replaced. 1.1.3 There are real costs, financial and non-financial, associated with the lack of necessary equipment in certain facilities. 1.1.4 The budget allocated by Treasury to the WCDOH is currently not sufficient to meet the annual equipment demands of all facilities, and by inference, insufficient to reduce and/or eliminate the existing backlog. [ Annexure C. Botha, T. 26 March 2012] 1.1.5 Strategic Partnerships, efficiency, innovation, stretching the healthcare rand and patient-centricity are all at the very heart of achieving the objectives of the WCDOH. [ Annexure C. Botha, T. 26 March 2012] 1.1.6 The WCDOH only wishes to consider operating leases and NOT finance leases. 1.1.7 Possible assets which could be leased, if this route were followed, would be limited to: a) High-value, high redundancy, high maintenance, high technology assets, required at the three Central [Tertiary, Educational] Hospitals and other facilities b) Transversal IT systems of hardware and or networks or systems which would support the WCDOH Information Management data capabilities. 1.1.8 The process must adhere to all of the relevant regulatory frameworks and the WCDOH‟s existing procurement process must be enhanced. 1.1.9 The “Essential Equipment List” for Central, Regional and District Hospitals and clinics is also considered, as well as the transversal IT requirements. This would imply that such asset planning should extend beyond the Medium Term Expenditure Framework [MTEF].[]4|Page
  • 1.2 DECISIONS REQUIRED 1.2.1 Principle agreement to pursue alternative finance strategy, procurement policy and operating leasing along with triple bottom line partnerships within WCDOH. 1.2.2 Principle agreement to allow for individualized projects and case studies to be conducted, under empirical conditions and within regulatory and policy frameworks, so as to evaluate the qualitative, quantitative, tangible as well as intangible benefits of operating leasing and alternative finance and procurement strategy over time. 1.3 ACKNOWLEDGEMENTSThis document is the culmination of a year-long investigative process that has involvedinterrogation of data, research, interviews, robust debates, lobbying and hard work, dedicationand passion from a great many people. In no specific order, I wish to acknowledge the followingpeople:  Minister of Health, Mr Theuns Botha and Head of Department: WCDOH, Prof Househam, for having the vision and foresight to provide the mandate for the exploratory process.  Mr Mike Loverock: Independent Financial Analyst – for assisting with the creation of the financial models and scenarios.  Mr Isaac Smith: Head of Procurement: WCDOH – for bringing his experience, knowledge, skills and wisdom to bear whenever required.  Messrs Van Niekerk, Jooste and Manning: Financial Management team: WCDOH – for their openness to engage with new, innovative and different ideas and concepts.  Manufacturers and suppliers of medical and other high technology equipment – for their inputs regarding mechanisms that would add value to the procurement and life-cycle of assets.  Various officials, managers, role players and staff within Level 2 and 3 health facilities as well as senior officials and management within WCDOH Head Office, too many to mention by name - for their input in terms of desirability, feasibility and viability.The intent remains for this to be a living document as we move towards becoming the LearningOrganisation [Liao, S. H., Chang, W. J., Wu, C. C., & Katrichis, J. M. 2011]. The hope is to arrive ata policy solution which would deliver against the range of objectives of the WCDOH, whilstmitigating any potential future financial and environmental risks. The report and recommendationsif adopted in its entirety will lead to the more effective use of capital, reduction in costs andincreases in available budget or free cash flow to WCDOH.AMANDA BRINKMANNSpecial Adviser to the Minister of Health & Leader of Government BusinessHOD: Strategic Partnerships: Western Cape Government5|Page
  • 2. PROBLEM STATEMENT 2.1 An asset/equipment backlog exists generally within the WCDOH, but specifically at the three Tertiary, Central Hospitals. 2.2 Some, or all, of the facilities managed by the WCDOH have a shortage of equipment and/or ageing or obsolete equipment that need to be upgraded or replaced. 2.3 There is particular need, as evidenced by the attached proposal titled: Strengthening of the Surgical Platform: Western Cape Department of Health. [Brinkmann, A. November 2011] for surgical theatres, suites and training facilities to be upgraded. 2.4 There are real costs, financial and non-financial, associated with the lack of necessary equipment or the presence of ageing, inefficient, sub-optimal equipment in certain facilities. 2.5 The budget allocated by Treasury to the WCDOH is currently not sufficient to meet the annual equipment demands from all facilities, and by inference, insufficient to reduce and/or eliminate the existing backlog. [ Annexure C. Botha, T. 26 March 2012] 2.6 National Treasury has issued a notice indicating a tightening of the budgetary envelope. The estimated time horizon is anticipated to be three to five years. [National Treasury Department: South Africa. August 2012] 2.7 Notwithstanding the above, negative impact on service delivery is not an option as is evidenced by the Strategic Objective Four of the WCDOH as set out within the Annual Performance Plan 2012/13[Annexure D: Western Cape Department of Health. March 2012] as well as with the spirit, content and objectives of Vision 2020 [Annexure B: WCDOH. November 2011]. This is reiterated within the content of the WCDOH Budget Speech 2012. [Annexure C. Botha, T. 26 March 2012] 2.8 There is an acute shortage of doctors and nurses in South Africa and Minister Aaron Motsoaledi, National Minster of Health, has committed to the training of additional clinical staff and the upgrade of facilities [Child, K. 11 Oct 2011]. 3. OBJECTIVESThrough innovation in financial, procurement and strategic partnership strategies and policies,within severe budgetary constraints, ensure improved delivery of the various strategic objectivesand service delivery outcomes of WCDOH as well as those of the Western Cape Government[WCG] as a whole, without compromising either the present or future delivery of such services.6|Page
  • 4. METHODOLOGY AND APPROACH 4.1 The existing capital structure [Flynn, D.2009. Chapter 13-3] and capital budgeting structure [Flynn, D. 2009. Chapter 14-3] of WCDOH was interrogated and evaluated in respect of efficiency and effectiveness. 4.2 The Five Principles of Financial Viability [Flynn, D. EDP 2012. Slide 26] were borne in mind, adjusted for governmental circumstances. 4.3 The existing „Essential Equipment List‟ was assessed against what is required in reality and adapted accordingly. 4.4 The benefits of new assets as well as replacement assets have been sufficiently quantified for comparison against the opportunity cost of incurring finance costs. 4.5 Various pieces of legislation, policies, regulations, practice notes, strategies and plans, as referenced within and annexed to this report were interrogated and reviewed. 5. EXISTING FINANCIAL STRATEGY, PROCUREMENT POLICY and OPERATIONAL REALITIES: WCDOHIn summary, WCDOH currently employs the following financial strategies and policies: 5.1 Historic, Incremental Budgeting or Capped Budgeting 5.2 Working Capital Structure allows for the purchase of fixed assets mainly via outright cash purchase 5.3 Valuation and Value are not quantified on the principles of risk and return in finance 5.4 Useful life of assets and operational maintenance are not adequately planned and budgeted for 5.5 Budget priorities are not necessarily reflective of changing service delivery needs and requirements 6. FINANCE STRATEGY AND PROCUREMENT POLICY ALTERNATIVES and OPPORTUNIES: DISCUSSION 6.1 ZERO-BASED & ACTIVITY BASED BUDGETINGA hybridized version of a zero-based and activity based budgeting approach would allow for thebudget to be built around what is needed to deliver on the objectives of WCDOH. 6.2 FINANCE DECISIONS AND OPTIMAL CAPITAL STRUCTURES 6.2.1 Gearing or LeverageAn optimal capital structure strikes a delicate balance between cash funding and funding fromdebt. An element of gearing or leverage, at a moderate level, could have the ability of bringing7|Page
  • future procurement into the present. Long-term assets should ideally be procured via long-termfinance. Benefits and use are realized over time. [Flynn, D. 2009] 6.2.2 Financial instrumentsOperational Leasing could fast-track the procurement of high technology, high maintenance, highredundancy and high value equipment. Innovative contractual agreements between WCDOH,Lessors and suppliers of assets could provide considerable added value. 6.2.3 Establishing the full value of assetsNew techniques to establish the value of assets should be agreed based on the principles of riskand return in finance. 6.3 UPFRONT PURCHASE OF MAINTENANCE CONTRACTSWCDOH could purchase maintenance contracts up-front. This could lead to savings of up to 25%.[Lipsitz, N. 6 October 2011] 6.4 GREEN PROCUREMENTThe White Paper on Greening the Procurement of Goods and Services within the Western CapeGovernment [The Department of Environmental Affairs and Development Planning: Western CapeGovernment. 21 June 2011] provides as follows: 6.4.1 Life-cycle analysis, costing, planning, sustainability and resource efficiency so as to prolong the useful life of assets and re-use as long as possible. 7. OPERATING LEASEIn general, leasing is based on the concept that for the purpose of production / service delivery,the determining factor is not the ownership of the assets to be acquired, but rather theiravailability for use. [National Treasury.1 April 2000] 7.1 GENERAL ADVANTAGES OF AN OPERATING LEASE 7.1.1 Creating free cash flows within a budgetary constrained environment 7.1.2 Spreading the Cost by initially paying for use, thereby matching the costs of an asset against the asset‟s future economic service potential 7.1.3 Complete Finance 7.1.4 Flexibility to add to or upgrade the asset base when required 7.1.5 Vendor Independence 7.1.6 Acceleration of service delivery projects via gearing 7.1.7 Transparency in contracting which improves governance [ Accessed August 2012]8|Page
  • 7.2 KEY BENEFITS OF OPERATING LEASING TO WCDOH 7.2.1 FINANCIAL EVALUATION and BENEFITS OF OPERATING LEASINGAnnexure F: TABLE ONE: OPERATING LEASING BENCHMARK SCENARIO MODEL REFERSThe financial model was built on the following assumptions:  WCDOH CAPEX budget for equipment is set at R200 million per annum.  Budget growth: 5% per fiscal, which effectively neutralises inflation.  Of the R200 million 2011/2012 budget, 50% [R100 million] is allocated to the procurement of high value assets.  WCDOH determines to acquire equipment to the value of R75 million via operating leasing and the balance of R25 million via outright cash purchase.  The equipment identified as appropriate for rental has an estimated minimum useful life of seven years. To ensure the highest level of healthcare delivery, such equipment will be replaced at the end of year five, but will continue in use at a separate / tier two facility for its remaining economic life.  All rates used in the cash flow evaluation are at market rates as at April 2011.Western Cape - Department of HealthCapital Expenditure Budget 2011 – 2016Annual increase 5% 2011/20121. Allocation for low-value equipment and other assets 100 000 0002. Allocation for big-ticket assets * 100 000 000Budgeted Expenditure 200 000 000Cash FlowsAnnual Budget 2011/2012 100 000 000 Cumulative 0Rental Cash Flows 2011/2012 (17 601 918) Cumulative 0Cash Differential Current Year 82 398 082 Cumulative 0Less: (assets not rented) Current Year (25 000 000)Available Cash: Current Year 57 398 082 Cumulative 82 398 0829|Page
  • The table and its summary above are interpreted as follows: From the rental cash flow in 2011/2012 costs of only R17.6 million is incurred. This creates a potential for gearing, at an applied factor of 4.5 (75 million / 17.6 million. This form of acceleration may be imprudent on an annual basis, because of the cumulative effect of rental payments on succeeding years‟ budgets. Acceleration in the 2011/2012 and again in the 2014/2015 budget years have been assumed, with the cash flow effects thereof running through until the 2018/2019 budget year. Consistent with the analysis for the 2011/2012 year, a surplus cash position of approximately R50 million is reflected for the 2014/2015 year, which in turn creates the ability for WCDOH to once more accelerate the procurement of equipment. A financing strategy of this nature could be regarded as a moderate approach to asset procurement, within which there are countless permutations. A vital component in the strategic decision-making process in general, but specifically in this regard, is the potential cost savings that accrue to the WCDOH. 7.2.2 PROPOSED STRUCTURE OF OPERATING LEASING AGREEMENTS  The Lessor [who is vendor-independent] will purchase the assets from the supplier/s selected by WCDOH at the best possible price, and  The Lessor will negotiate a discounted up-front maintenance/service contract,  The Lessor will include Extended Producer Responsibility into the contract,  The Lessor and Vendor agree to redeploy assets into lower-tier health facilities at their cost, which costs shall include transport, installation, full maintenance and training of clinical staff, where relevant  The Lessor will lease such assets to WCDOH at a fixed rate and over an agreed term, and  The Lessor, through a separate corporate social investment agreement with The Health Foundation, donates leased assets to the WCDOH, at the end of the agreed lease period.10 | P a g e
  • 7.2.3 COST REDUCTIONS, BENEFITS, SAVINGS: ACCRUING TO WCDOHFrom a purely [and very limited] financial perspective, I would suggest that the acid test here is toobtain comfort that the cost savings and benefits that accrue, at least exceed the costs of finance. Ability to purchase up to four times more equipment by gearing moderately in specific budgetary period Creating free cash flows within the specific period so as to assist with service delivery within financially constrained circumstances By having state-of-the-art equipment at teaching hospitals, the ability to attract, train and retain the best possible clinical talent in the province and country By upgrading the surgical platform alone, it is anticipated that vast savings in respect of patient experience, recovery, reduction in bed days, post-operative morbidity and mortality would be achieved The value of bringing future delivery into the present via sound finance and procurement policies Over time, replace obsolete and ageing equipment with sustainable, energy-efficient assets Inclusion of Extended Producer Responsibility into contractual agreements ensures that the useful life the asset is extended as far as possible and that the cost of disposal is vested in the producer By planning for the acquisition of assets over the MTEF, a five, seven and ten year horizon can be constructed; planning for the redeployment of assets to lower- tiered facilities could be included into such planning The cost of relocation, installation and training of staff related to assets will be borne by the producer Lower-tiered facilities will, over time, be able to diagnose and treat patients in situ, thereby improving prognosis and overall patient outcomes, potentially saving the health system considerable costs attached the late detection and treatment of certain conditions Savings related to the reduction in the maintenance division and budget of the WCDOH over time as well as savings related to the up-front procurement of maintenance contract, acting to mitigate finance costs over the term Savings in transport of patients via Health Net – fuel, driver, support staff salaries and consumables used en route Hospitalisation costs at the facility to which the patients would have been taken, which may include more bed days than would otherwise have been necessary Savings in loss of man days [ and the costs thereof] related to providing at treatment at facilities that are remote from the patient‟s home General improvement of the patient experience and a complete move towards the stated goal of patient-centricity by equipping the health network with improved capacity and diagnostic abilities closer to where the patient is Demand management, Disposal Management, Extended Producer Responsibility, Full-life cycle assessment, costing and planning and contractual innovations would optimize capital expenditure and asset acquisition Improved staff morale and motivation over time11 | P a g e
  • 8. CONCLUSIONS 8.1 The existing planning, finance strategy and procurement policies within WCDOH are not optimised to deliver against the changing service delivery needs of patients as well as clinicians. 8.2 The very constrained budgetary environment necessitates looking at new and innovative capital and finance structuring methodologies. 8.3 To achieve societal outcomes, there is a shift towards partnering via the sustainability platform as is evidenced by the findings attached to the establishment of The Health Foundation [ Ernst & Young. 9 February 2012. Annexure A] as well as the outcomes of the UN Global Compact/Accenture CEO survey[Lacy, P; Cooper, T; Hayward, R; Neuberger, L. June 2010]. 8.4 Green procurement policy and principles provide significant additional opportunities to save costs and improve efficiencies. [DEADP. 21 June 2011] 8.5 There is a compelling case to be made for the use of Operating Leasing and the proposed contractual structure so as to accelerate service delivery and reduce the existing equipment/asset backlog. 8.6 Such policy has the potential to benefit other departments within WCGOV. Department of Education and the acquisition and renewal of ICT infrastructure spring to mind. 8.7 The proposed gearing factor of 4.5 could in essence accelerate asset procurement by more than 100% every 3 years. 8.8 By implementing a prudent and moderate operating leasing procurement strategy, significant long term savings and benefits could accrue to the WCDOH, its patients and employees. 8.9 The proposed upgrade of the Surgical Platform in the province, with further reference to the acquisition of equipment and training in Laparoscopy or Minimally Invasive Surgeries [Heisler, J. January 2012.] could lead to significant cost-savings to the health system as well as improved patient outcomes. This is evidenced by the outcomes of a range of global studies.[Braga, M. et al. Dec 2005]; [Rodriguez, A et al. January 2011.];[Maslekar, S. et al.March 2007.]; [Roumm, AR. Pizzi, L et al. March 2009.]; [Goldsmith, H. Herman, L. January 2002.] 8.10 It goes without saying that any form of funding [bond, loan, finance lease, operating lease] carries a financing cost. The WCDOH budget, which is allocated from Treasury, of course does not carry such a cost, at least not to the WCDOH. 8.11 If the only analysis undertaken is to compare the allocated cash [per the WCDOH budget] to any form of debt financing, and the end objective of the analysis is the12 | P a g e
  • quantum of assets that can be acquired over time, by definition cash will always prevail, by virtue of the financing costs of debt. 8.12 Additional assets made possible through the use of alternate finance strategies, whilst not generating income, could have a material impact on reducing costs. 8.13 Examples of these costs are dealt with in the main document, and should be identified within the operating budget, and quantified. These could correctly be considered hard cash savings that accrue to the WCDOH, and a tangible benefit. 8.14 A meaningful and correct analysis in comparing a cash purchase to an operating lease solution is then to include a line in the budget in which these cost savings are recorded. 8.15 Properly managed financing costs can be seen as the price that the WCDOH pays for the ability to bring the procurement of essential medical equipment from future years into the now. Coupled to this ability, is the concomitant reduction in associated expenses. 8.16 We have to shy away from a purely rands and cents analysis when considering the cost benefits of employing a moderate operating leasing strategy. 8.17 Whilst an operational lease is subject to compound interest over the lease period, this cost should ideally be weighed up against the short-to mid-term benefits as described within this report. 8.18 Although difficult, it would be useful to compare the full, actual cost of assets procured by cash over the complete useful life of the asset. 8.19 Assets are generally „sweated‟ for as long as possible, but the cost of running an operational maintenance unit is not factored in, accounted or budgeted for adequately. [Gartner Group. 2003]. The complete cost of ownership of state assets is therefore not known. 8.20 The proposed new standard for leases moves away from the current „risk and returns‟ basis to a „right of use‟ basis. This adjustment would make accounting for leases more congruent with the Conceptual Framework for Financial Reporting 2010, as drafted by the International Accounting Standard Board. [IASB.2010] 8.21 By continuing on a „ business-as-usual‟ path, the backlogs in equipment will not be addressed and this would have material impact on the ability of WCDOH to achieve its strategic objectives.13 | P a g e
  • 9. RECOMMENDATIONSGiven the constrained budgetary environment, the range of strategic objectives as iterated by theWCDOH as well as Western Cape Government in general and the need to innovate so as to stretchthe health rand, the following recommendations are made for consideration by the Committee: 9.1 Zero-based and activity based budgeting to establish the real needs as required to deliver against the objectives of WCDOH, specifically as those deliverables would up operational efficiences, save costs in the longer term, improve quality and access to services and be focused entirely on patient-centricity. 9.2 Based on the latter activity, develop a phased, rolling 10-year asset procurement plan, that would seek to address the most immediate priorities over time. 9.3 These priorities would, in the main, be related to high technology, high redundancy, high maintenance and high value assets. This should include ICT and management information infrastructure. 9.4 Explicit rules need to be established which define the potential assets which would be considered. 9.5 Key priority requirements should be projectised. 9.6 Such projects and case studies would be decided based on the necessity of the procurement of such equipment so that such procurement aligns with delivery of the Strategic Objective Four [ 4] of the WCDOH as set out within the Annual Performance Plan 2012/13[Annexure D:Western Cape Department of Health. March 2012] as well as with the spirit, content and objectives of Vision 2020 [Annexure B: WCDOH. November 2011]. Such projects would furthermore be guided by the content, intent and spirit of the WCDOH Budget Speech 2012. [ Annexure C. Botha, T. 26 March 2012] 9.7 Certain projects, such as for instance the upgrading of the Surgical Platform in the province, could be managed by the Strategic Partnerships portfolio in collaboration with The Health Foundation. This recommendation is based upon the fact that a significant number of suppliers, manufacturers and donor partners have already indicated their support for such a project. The balance of funds which are not secured via such partnerships and donations could be financed by WCDOH. 9.8 Operating Leasing, used in a moderate and pragmatic manner should be adopted as part of the WCDOH‟s finance and procurement policy and strategy. 9.9 The proposed structure of the Operating Leasing agreement, as proposed within this report should be adopted and all contracts negotiated on this basis so that the full added value benefits to WCDOH and its patients are realised over time. 9.10 The benefits of new as well as replacement assets must be quantified in order to assess this cost against the opportunity cost of incurring finance costs.14 | P a g e
  • 9.11 Factors, including: Net Present Value calculation should include, amongst others: * Value of the asset * Funds being paid * Maintenance costs * Administration costs* Potential staffing costs * Disposal value/cost of asset used * Environmental costs* Input materials and resources required to operate the asset * Capital cost of the asset* Positive cash flows that the asset is expected to generate, net of financing costs *Changes to working capital requirements 9.12 Other than cash flows as basis for the valuation technique, other factors, such as the capacity to influence existing and future service delivery, capacity to influence future cash flows, capacity to generate present and future benefits, rewards or savings, timing of cash flows and impact of the investment on the business operations should be taken into consideration. WCDOH must appropriately evaluate whether the benefits of ownership of equipment or assets in the present, seem to be greater than the wealth foregone, expressed as the price. We should establish whether the total exchange price is in reality lower than the value or worth of the asset to WCDOH. 9.13 Accounting for leases must be congruent with the Conceptual Framework for Financial Reporting 2010, as drafted by the International Accounting Standard Board [IASB] as well as Finance Instruction G22/2009. [Jooste, J. 27 March 2009] 9.14 Finally, it is my assessment, based on all of the information gathered, assessed, interrogated and discussed over the past year, subject to internal compliance issues being satisfied, that an Operating Lease methodology as proposed within this report can generate compelling and very real benefits to the WCDOH and should therefor form part of the overal finance, procurement and funding strategy. 9.15 In general, the Finance, Investment and Capital structures of WCDOH should be reviewed so as to be in more in keeping with the delivery of the strategic objectives of the Western Cape Government, The Western Cape Department of Health and with the changing service delivery and business landscapes.The report and recommendations if adopted in its entirety will lead to the more effective use ofcapital, reduction in costs and increases in available budget or free cash flow to WCDOH.15 | P a g e
  • 10. REFERENCES: FINANCIAL STRATEGIES REPORT AND RECOMMENDATIONSBotha, T. 26 March 2012. Western Cape Health Budget Speech 2012 by Mr Theuns Botha,Minister of Health at Western Cape Provincial LegislatureBraga, al. December 2005. Laparoscopic versus open colorectal surgery: cost-benefit analysisin a single center randomized trial.Campbell, R. H. 2012. Define:Financial Lease. Accessed August 2012Child, K. 11 Oct 2011. Health Minister promises more doctors and nurses. September 2012Enterprise Financial Solutions. 2012. Definition of Operating LeaseErnst & Young. 9 February 2012. The Health Foundation: The Journey Thus Far. Presentationformat.Flood, R.1999. Rethinking the Fifth Discipline: Learning from the Unknowable.Flynn, D. EDP 2012. Financial Strategies Presentation document.Flynn, D. 2009. Understanding Finance & Accounting. Chapter 6. Pg 27. 6. Non-financial issues inanalysis; 6.1 The Balanced ScorecardGartner Group. 2003. Total Cost of Ownership model.Goldsmith, H. Herman, L. January 2002. Endoluminal gastroplication. A new therapeuticendoscopic procedure for gastro-esophageal reflux disease.Heisler, J. January 2012. Definition of Laparoscopic Surgery. Guide. Accessed August2012 Define: Positive CashFlows. Accessed September 2012 Basic Finance for Marketers. Advantages ofOperating Leases. Accessed August 2012. Define: Net Present Value [NPV]. AccessedAugust 2012. Define: Operating Lease. AccessedAugust 2012.16 | P a g e
  • Definition: Medium TermExpenditure Framework [MTEF]. Accessed September 2012International Accounting Standards Board [IASB]. 2010. The Conceptual Framework for FinancialReporting. Accessed August 2012Jooste, J.M. March 2009. Finance Instruction G22/2009. Classification of Lease Agreements in theStandard Chart of Accounts as well as the Reporting on Lease commitments at the end of eachfinancial year.Lacy, P; Cooper, T; Hayward, R; Neuberger, L. June 2010. A New Era of Sustainability. UNGlobal Compact Accenture CEO Survey study 2010. ; CEO reflections on progress to date,challenges ahead and the impact of the journey toward a sustainable economy.Liau, S.H.,Chang, W.J., Wu, C.C. & Katrichis, J.M. 2011. A survey of market orientation.Lipsitz, N. 6 October 2011. CT Tender: Savings on upfront maintenance contracts: Siemens andCity of Cape TownMaslekar, S. et al. March 2007. Cost analysis for trans-anal endoscopic micro-surgery for rectaltumoursNational Treasury Department: South Africa. August 2012. Medium Term Expenditure FrameworkGuidelines. Preparation of Expenditure Estimates for the 2012 Medium Term ExpenditureFramework.National Treasury: South Africa. Public Finance Management Act No. 1 of 1999 [PFMA]. Date ofcommencement: 1 April 2000. Updated to Government Gazette 33059, 1 April 2010.Public Finance Management Act No1. Of 1999 [PFMA]. Date of Commencement: 1 April 2000.Gazette#25915. Public-Private Partnerships issued in terms of the Public Finance ManagementAct. Treasury Regulation 16.Rodriguez, A et al. January 2011. Providing endoscopy for underserved patients benefits publichealth and resident education.Roumm, AR. Pizzi, L et al. March 2009. Minimally invasive: minimally reimbursed? An examinationof six laparoscopic surgical procedures.The Department of Environmental Affairs and Development Planning [DEADP]: Western CapeGovernment. 21 June 2011. Draft White Paper on Greening the Procurement of Goods andServices within the Western Cape Government. Provincial Gazette Extraordinary No. 6880Vancock, H. 2007. "Dimensions of sustainability". Journal of Engineering for SustainableDevelopment: Energy, Environment, and Health 2 (1): 47–57.Western Cape Department of Health [WCDOH]. November 2011. 2020 –The Future of Health Carein the Western Cape. A Draft Framework for Dialogue17 | P a g e
  • Western Cape Government Department of Health. March 2012. Health Annual Performance Plan2012/13. www. Accessed March 2012.18 | P a g e
  • 11. GLOSSARY OF TERMS and ANNEXURESGLOSSARY OF TERMS1. Non-financial issues in analysisThis methodology takes issues of interest and benefit to a variety of stakeholders into account,which issues may not be directly viewed as being able to be measurable in financial terms. Theseissues nonetheless add value and so to provide a complete analysis, should be considered as partof emergence: the whole being larger than the sum of the parts. [Flynn, D. 2009]This requires systemic evaluation rather than the quite one-dimensional practices that are oftenused in analysis models and requires a leap from current conservative measurement metrics toWilliam Flood‟s integrated model of systems thinking, design and systemic evaluation. [Flood,R.1999]2. The Balanced ScorecardThe Balanced Scorecard focuses not only on the financial outcomes, but also on the operational,marketing and developmental facets of a company/organisation. This tool links the objectives andstrategies of the organisation to measurable outcomes, but not only in financial terms. One of themain challenges for financial management is to identify and agree on the strategies that wouldachieve the overall goals and objectives of the organisation via a process of strategy mapping.The further challenge is inherent in apportioning weighted values or quantum‟s to such non-financial outcomes. [Flynn, D. 2009]3. The Triple Bottom LinePeople. Profit. Planet.In her article, titled, Dimensions of Sustainability, published in the Journal of Engineering forSustainable Development, Energy, Environment and Health, Hasna Vancock [ Vancock, H. 2007]speaks to the fact that sustainability is a process – this process deals with the development of allaspects of human life that affects sustenance. This process involves constantly trying to balanceconflicting goals, objectives and interests and involves the simultaneous pursuit of economicprosperity, environmental quality and social equity, known as the three dimensions or the Triplebottom line. Triple Bottom Line Reporting is fast becoming mandatory for listed companies andgovernment.4. Finance LeaseA agreement where the lessor receives lease payments to cover its ownership costs. The lessee isresponsible for maintenance, insurance and taxes. Some finance leases are conditional sales orhire purchase agreements. [Campbell, R.H. 2012]5. Operating LeaseA contract that allows for the use of an asset, but does not convey the rights of ownership of theasset to the lessee. An operating lease is not capitilised; it is accounted for as rental expense inwhat is known as „off balance sheet financing‟. For the lessor, the asset being leased is accountedfor as an asset and depreciated as such. Operating leases result in assets or liabilities not beingrecorded on the lessee‟s balance sheet. This can improve the lessee‟s financial ratios.[]19 | P a g e
  • 6. Capital StructureCapital is a scarce commodity. The objective of business management is to create value and addvalue by the correct allocation of scarce resources. There are two primary ways in which capitalis used to return in an operating business. These are investments in fixed assets and in currentassets that are referred to as working capital items.Financial Management has to align the capital structure of an organisation[debt; equity; cash; liquidity] to achieve the objectives, strategies and desired outcomes of thebusiness most optimally. [Flynn, D. 2009. Chapter 13-3]7. Capital BudgetingIn the case of government, capital budgeting is the process of evaluating projects that generateimprovements in service delivery outcomes and that align with the achievements of the StrategicObjectives of a particular department and the provincial government as a whole. In its broadestsense, the term is used for any expansion or replacement decision.All of the principles of capital investing are pertinent to capital budgeting. The capital investmentdecision must earn the required return on investment in order to add value or by adding value tothe activities of the organisation.Capital budgeting decisions are generally considered to be more risky than working capitaldecisions, because capital budgeting decisions carry long-term commitments of funds and are noteasily reversed if they prove to be unsuccessful. [Flynn, D. 2009. Chapter 14-3]8. Net Present Value [ NPV]This methodology compares the value of a rand today to the value of the same rand in the future,taking inflation and returns into account. If the NPV of a prospective project is positive, it shouldbe accepted. Conversely, if NPV is negative, the project should probably be rejected because cashflows may also be negative. []9. Positive cash flowCreating a situation where cash inflows during a period are higher than the cash outflows duringthe same period. Positive cash flow, in the case of government, does not mean profit. It isachieved due to the careful management of cash inflows and expenditure.[] The Capital Structure [Flynn, D. 2009. Chapter 13-3] plays alarge role in determining an organisation‟s positive or free cash flows.10. Working capital policies and managementFinancial managers constantly grapple with decisions relating to risk and return in all aspects ofthe business. Working capital is no exception. This decision is also a clear risk and return issue.Managers must decide how much of the scarce resources of capital should be invested in inventoryand debtors and then determine the extent to which creditors will be used to finance furtherinvestments. In government terms, a more conservative policy would aim to be less reliant onshort-term credit, financing a greater proportion of current assets through the use of longer-termfinance. [Flynn, D. 2009. Chapter 13-3]Commentary: Within the context of the report presented, working capital policies arerecommended so as to free up much needed cash flows within the narrowing fiscal envelope,20 | P a g e
  • whilst not compromising on the ability to procure much needed equipment required to improveservice delivery in the immediate future.11. The Learning OrganisationIn their abstract, A survey of market orientation research [Liao, S. H., Chang, W. J., Wu, C. C., &Katrichis, J. M. 2011], we become aware that a Learning Organisation refers “to an organisation-wide activity involved in creating and using knowledge to enhance competitiveness”.12. Laparoscopic SurgeryLaparoscopic surgery, also known as minimally invasive surgery, is a technique that allows surgeryto be performed without the long traditional incision. By using multiple small incisions, each a fewcentimeters long, the surgeon inserts instruments including a tiny camera. The camera allows thesurgeon to visualize the surgery. Incisions are made through the skin, muscle and other tissue,making laparoscopic surgery safer as less tissue is cut [Heisler, J. January 2012.].13. Extended Producer ResponsibilityExtended Producer Responsibility is based on the „Polluter pays‟ principle and entails makingmanufacturers responsible for the entire lifecycle of the products and packaging they produce.This means companies that manufacture, import and/or sell products and packaging, are requiredto be financially or physically responsible for such products after their useful life. They must eithertake back spent products and manage them through reuse, recycling or in energy production ordelegate the responsibility to a third party which is paid by the producer for the spent-productmanagement. [DEADP.June 2011]14. Life-Cycle Costing Analysis or Life-Cycle Cost AssessmentThis is a procurement evaluation technique which determines the total cost of acquisition,operation, maintaining and disposal of the items acquired; the lowest ownership cost during thetime the items is in use. [DEADP.June 2011]15. Disposal ManagementThis refers to the decommissioning, clearance and removable of unserviceable, redundant andobsolete assets. It considers obsolescence planning; maintaining a data base of redundantmaterial; inspecting material for potential reuse; determining a disposal strategy; and executingthe physical disposal process. [DEADP.June 2011]16. Capped BudgetingBudgeting is done by using historic or incremental budgeting, which has, in the main, the neteffect of not necessarily being able to keep pace with the constantly changing healthcare needs ofthe citizens of the province or the changes required within the healthcare system as a whole.Capped budgeting, by inference, remains unchanged, irrespective of the changing needs of theorganization and its clients.21 | P a g e
  • 17. Zero-based Budgeting and Activity-Based BudgetingExpenses are justified for each new period and starts from a zero base. Each function within theorganization is analysed for needs and costs and budgets are built around what is need for the up-coming period, regardless of whether such budgets are higher or lower than the previous period.This allows for strategic goals to be implemented into the budgeting process.Activity-based budgeting means that all activities that incur costs in every functional area of theorganization are recorded, their relationships defined and analysed. Activities are tied to thestrategic objectives, after which the cost of the activities are used to create the budget. This alsoprovides opportunities to streamline costs and improve business processes and activities. [Flynn,D. 2009]22 | P a g e
  • ANNEXURE B: 2020 – The Future of Health Care in the Western Cape. A DraftFramework for Dialogue: Key excerpt of material relevance to the Report andRecommendations“It is important to reflect on the achievements to date, what worked (and what did not) and thelessons learned. While a formal external evaluation of the 2010 plan has not been undertaken, thisdocument summarises the most important achievements and lessons learned. An important themethroughout the document is what should be done differently. (Section A).”“What is the case for change? The compelling motivation for change includes changes in provincialdemography, socio-economic determinants of health and the burden of disease; advances intechnology; and the global, national and provincial policy environment. Sustaining the currentgood practices, and improving others, is key to becoming a world class organisation. Wemust focus on key priorities and the most cost-effective interventions within the limitedresources available. (Section B)”“The planning for 2020 takes cognisance of both national and provincial policy developments.Important policy frameworks include the “green paper” on the National Health Insurance, thenational Human Resources for Health framework and the provincial strategic plan, with particularemphasis on Strategic Objective 4 (Improving Wellness). (Section B).”“Prevention of disease and the promotion of wellness is the basis of health service development.The upstream factors that contribute to the burden of disease will be addressed with the relevantstakeholders through a “whole of society” approach. This approach has been recently endorsedthrough the Cape Town Declaration on Wellness. The Department of Health will focus onprevention and downstream promotion within the health service delivery platform. (Annexures Aand B).”“The Department has drafted a broad strategic overview of a desired health care system in 2020.Seven guiding principles have been identified to guide the 2020 strategy (Section C):1. Patient-centred quality of care2. A move towards an outcomes-based approach3. The retention of a Primary Health Care philosophy4. Strengthening the District Health Services model5. Equity6. Affordability7. Building Strategic Partnerships “24 | P a g e
  • ANNEXURE C: WESTERN CAPE HEALTH BUDGET SPEECH 2012 BY MR THEUNS BOTHA,MINISTER OF HEALTH AT THE WESTERN CAPE PROVINCIAL LEGISLATUREEXCERPTS OF MATERIAL RELEVANCE TO THE REPORT AND RECOMMENDATIONS“Creating WellnessThe department is now engaged in planning for 2020 to determine the service requirementsgoing forward to 2020 and beyond. It will enable human resources, infrastructure and otherrequirements to be identified that will shape the future services. At the heart of the visionfor 2020, there is a renewed commitment to a quality, caring and patient-centred healthservice and improved health outcomes where the care pathways will be designed torespond to patient needs.”“The shift in focus from illness to one of promoting and seeking wellness that gained significantground during 2011/2012 culminating with the Wellness Summit and the ensuing Cape TownDeclaration will be further strengthened in the coming year. In particular, I am committed todeveloping wellness centres that will increase the access in communities to health services andactivities promoting a healthier lifestyle.”“Public private partnershipsPartnership with a range of stakeholders have increased year-on-year during the term ofthis government. In the past two years, the province has been able to secure successfulpartnerships with the private sector that have led to significant contributions to ourhealthcare system. These public-private partnerships leverage the talents of the privatesector for the benefit of public sector patients. It is based on a win-win philosophy thatimproves the physical health of patients and the financial health of the economy.”“Surgical skills training centreLocated at the Red Cross War Memorial Childrens Hospital, this centre is a partnership with theChildrens Hospital Trust and Karl Storz Endoscopy SA, the latter having donated R10 million inequipment and technical assistance. It is the only training centre on this continent forsurgeons-in-training from across Africa.”“Western Cape Health FoundationSupporting our efforts increase departmental income to address the R800 millionmaintenance backlog, we have appointed Ernst and Young Consultants, which resulted in theestablishment of the independent Western Cape Health Foundation.The Foundation will take responsibility for the Commercial Rights project and independentlyspearhead new and innovative initiatives to generate resources for health. This is asignificant step in strengthening this key relationship between the department and theprivate sector.I am encouraged that a number of prominent people, including Dr Paul Cluver, who will chair theboard of directors of the Health Foundation, have been willing to give of their time and energy topromote better health in the Western Cape. Clearly an example of people who also feel that it isbetter together! The Foundation will be publicly introduced in the coming months.These examples certainly demonstrate that the Western Cape has succeeded in responding withsolutions which have proved to bring about better health outcomes. At the heart of our25 | P a g e
  • provincial system is a commitment to accountability, affordability and efficiency - allnecessary elements for high-quality health outcomes.”“The focus areas of the department in the coming 2012/2013 financial year include: 1. Developing action plans to improve overall patient experience and quality of clinical care. 2. The full commissioning of the Khayelitsha Hospital. 3. Commissioning of the Mitchells Plain Hospital. 4. Finalising the 2020 strategy and plan for health services in the Western Cape. 5. Finalising the priority projects related to the Cape Town Declaration on Wellness including the:  High Five area approach to reduce alcohol-related injuries.  Healthy lifestyle campaign to decrease the incidence of chronic disease.  Programme to reduce intimate partner violence. 6. Improving maternal and child health outcomes. 7. Achieving an unqualified audit for finance, human resources and pre-determined objectives.”“ChallengesThe allocation to the department in 2012/2013, although increasing in nominal terms, ismarginally less in real terms than the 2011/2012 Adjusted Budget. The gap between theneed for health services and the available resources remains the challenge and increasesthe need to increase efficiency, work smarter and reprioritise services within theexisting baseline allocation.”“Distribution of the budgetThe budget of the department is divided between the eight budget programmes with R12.722billion or 87% of the vote being allocated to Programmes 2, 3, 4 and 5 which fund the directoperational costs of providing health services.Compensation of employees accounts for R8.478 billion or 58% of the total budget. Thedepartment has allocated approximately 31 % or R4.456 billion to the procurement of goods andservices, which amounts to approximately 55% of the goods and services procured by the WesternCape Government. ““Programme Three: Emergency Medical ServicesEmergency Medical Services, which is responsible for the provision of emergency medical transportincluding inter-hospital transfers and planned patient transport, is allocated R701 million or 4.8%of the vote.An amount of R15 million has been allocated provisionally for the InformationCommunication Technology system. This new computer-aided dispatch system, required toreplace the existing system, will provide both the communication centre solution and the vehicle-based solution. It is anticipated that the system, once implemented, will improve the efficiency ofthe ambulance dispatch process and will also provide real-time information. “26 | P a g e
  • “HealthNet is a transport service for our patients and the only-of-its-kind in the country. Wehave a fleet of 78 HealthNet vehicles, adapted for ill patients, which transport approximately4000 patients from rural areas across the province to central hospitals per month. The serviceemploys 95 personnel and performs outpatient transfers between levels of care.This transport infrastructure also transfers patients from primary healthcare facilities to regionaland district hospitals. Although the service is often under unfair scrutiny, the new electronicsupply and demand system will certainly improve the booking system, and address the problemsof misuse.”“Programme Four: Provincial Hospital ServicesThis programme is responsible for the provision of general specialist and specialisedhospital services that include tuberculosis, psychiatric, rehabilitation and dental training hospitals.Central hospitals, which are large functional service delivery structures, are integral to acoherent health care delivery system at provincial level. These hospitals are the healthfacilities where a majority of health sciences trainees are trained to become healthprofessionals, and where much of the health professional service skills, healthresearch and knowledge capital resides.The Western Cape is the only province that over a number of years attempted to define andmanage general and highly specialist services separately within the central hospitals. The fundingof these services was distributed accordingly to separate budgetary programs however afterconcluding that with the current information and management systems that this was not possiblethe department has reverted to funding the hospitals as functional entities. This reinforces theargument that to attempt to manage and fund these hospitals divorced from the health systemwithin which they function is not viable.”“Programme Five: Central Hospital ServicesThe central hospitals, Groote Schuur Hospital, Tygerberg Hospital and Red Cross ChildrensHospital, provide highly specialised healthcare services and a platform for research andtraining of health workers by the universities. All three hospitals provide highlyspecialised services as national referral centres.Central hospitals are allocated R4.212 billion or 28.8% of the vote in 2012/2013, which amounts toa nominal increase of R240.029 million or 6%.The total National Tertiary Services Grant of R2.182 billion, R270 million of the Health ProfessionsTraining and Development Grant and R3 million of the National Health Insurance Grant constituteapproximately 58% of the funding allocated to this programme. The balance of R1.757 billionallocated to the programme is derived from the provincial equitable share, which clearly illustratesthe extent of the underfunding of highly specialised services by the national conditionalgrants. Personnel costs are especially high in these hospitals constituting approximately 69% ofthe expenditure of this programme.The central hospitals will manage approximately 140 395 patient admissions in 2 545 beds and 1123 389 patient day equivalents at a cost of R3 244 per patient day equivalent.”“The provincial equitable share funding has been allocated as follows:  R47 million for the purpose of maintaining current infrastructure.  R11 million for preventive maintenance.  R180 million for the purpose of maintenance and capital expenditure.27 | P a g e
  •  R12 million for Red Cross War Memorial Childrens Hospital.”“Although the Western Cape does not support the National Health Insurance green paperin its current format, it does not mean that the province will not participate in the NHI pilotprojects.As an alternative solution, Western Cape Government proposes Universal Healthcare, builton a primary healthcare basis, similar to the structures implemented in the Western Cape atpresent, where patients are referred to regional and specialised facilities according to their medicalneeds, and government providing the transport infrastructure. The rest is governance-based ongood business principles - financial discipline, efficiency, equality, modernisation,monitoring and evaluation.The lesson we have learned in the Western Cape is that we can improve healthcare for everyoneby strengthening the positive elements of the public sector and removing itsdeficiencies on a planned and sustained basis. ““In the efforts to increase wellness by working together we can all be better together! If allthose who work in the department work effectively and efficiently and make the best useof the available funds to provide the best service, we can be better together!”“Improving the health status and well-being of the people of the Western Cape can only beachieved through partnerships, put differently by working better together we can all livea better life!Thank you!”28 | P a g e
  • ANNEXURE D: WESTERN CAPE GOVERNMENT HEALTH. ANNUAL PERFORMANCE PLAN.2012/13.EXCERPT SUMMARISING STRATEGIC OBJECTIVE FOUR [4]“The draft strategy for 2020 has two main thrusts, as described in the Strategic Objective:Improving Wellness (SO 4) that forms part of provincial strategic plan.Firstly, at the heart of the vision of 2020 is a renewed commitment to a caring, quality,patient-centric health service. The district health service, supported by all levels and sectionsof the service is the key vehicle to deliver this quality health service. The PHC philosophy implies acomprehensive health service across levels of care and the various sectors allowing for meaningfuland active participation by communities.The limited resource base compared to the need for health services demands a morefocused approach to improve health outcomes in the most efficient and productivemanner possible. The Department acknowledges that addressing these challenges requiresstrong partnerships with a range of role players.Secondly, there is an important conceptual shift from managing the consequences of the burdenof disease to improving wellness. Central to this approach is an increased emphasis on preventionand promotion by addressing the upstream risk factors that impact on health and wellness in thewhole of society. The endorsement at the Western Cape Health Summit held in November 2011 ofthe Cape Town Declaration on Wellness by approximately 250 delegates from all sectors of societyin the Western Cape was an important milestone in this regard. There are six focus areas thathave been identified and work is underway to identify, plan and implement projects in theseareas.”29 | P a g e
  • ANNEXURE E: FINANCE INSTRUCTION G22/2009CLASSIFICATION OF LEASE AGREEMENTS IN THE STANDARD CHART OF ACCOUNTS AS WELLAS THE REPORTING ON LEASE COMMITMENTS AT THE END OF EACH FINANCIAL YEAR1. The contents of this Finance Instruction must be brought to the attention of all officials concerned.2. Finance Instruction G19/2009 dated 10 March 2009 is applicable to the 2008/2009 financial year only and is repealed as from 1 April 2009. However Finance Instruction G22/2009 must be read in conjunction with Finance Instruction G19/2006 dated 13 April 2006.3. PURPOSE3.1 The purpose of this Finance Instruction is to provide guidance to all financial staff on the economic classification of lease payments in the budget and in BAS using the new SCOA accounts and segments. In addition the circular clarifies the link between the economic classification and the disclosure requirements in the Annual Financial Statements and also introduces the differentiation between Operational and Financial Leases.4. DEFINITION OF LEASE COMMITMENTS4.1 Lease commitments represent amounts owing from the reporting date to the end of the lease contract.4.2 A lease is a contract that gives the lessee (the renter) the right to use an asset for an agreed period of time in return for a payment or series of payments.4.3 A finance lease is a lease that transfers substantially all risks and rewards incidental to ownership of an asset. Title may or may not eventually be transferred4.4 An operating lease is a lease other than a finance lease.4.5 Economic life is the period over which an asset is expected to yield economic benefits or service potential to one or more users.4.6 Useful life is the estimated remaining period, from the beginning of the lease term, without limitation by the lease term, over which the economic benefits or service potential embodied in the asset are expected to be consumed by the entity4.7 The definition of a lease includes contracts for the hire of an asset, which contain a provision giving the option to acquire title upon the fulfillment of agreed conditions. These contracts are sometimes known as hire purchase contracts.4.8 It is common practice for contracts to be termed rental agreements. This therefore does not mean that this is excluded from being a lease. One still needs to go through the conditions of the contract to determine whether it is a finance lease or an operating lease.4.9 It is important to note that the payment of a lump sum amount (rather than regular periodic payment such as monthly payments) does not preclude lease accounting as such arrangements may still meet the definition of a lease.30 | P a g e
  • 5. DETERMINATION OF A FINANCE LEASE VS. OPERATING LEASE5.1 FINANCE LEASE Lessor Lessee Treat as a sale Treat as a purchase AssetLease that transfers substantially all the risks and rewards of ownership5.2 OPERATING LEASE Lessor Lessee Right to use the asset Lease that does not transfer substantially all the risks and rewards of ownership6. CLASSIFICATION OF LEASES6.1 The classification of leases is based on the extent to which risks and rewards incidental to ownership of a leased asset lie with the lessor or the lessee rather than on which party has legal ownership over the asset.6.2 Risks include the possibilities of losses from idle capacity, technological obsolescence or changes in value due to changing economic conditions. Rewards may be represented by the expectation of service potential or profitable operation over the asset’s economic life and of gain from appreciation in value or realisation of a residual value6.3 Although the following are examples of situations, which would normally lead to a lease being classified as a finance lease, a lease does not need to meet all these criteria in order to be classified as a finance lease:  The lease transfers ownership of the asset to the lessee by the end of the lease term;  The lessee has the option to purchase the asset at a price which is expected to be sufficiently lower than the fair value at the date the option becomes exercisable, so that at the inception of the lease it is reasonably certain that the option will be exercised;  The lease term is for the major part of the economic life of the asset even if title is not transferred;  At the inception of the lease the present value of the minimum lease payments amounts to at least 90% of the fair value of the asset.31 | P a g e
  •  The leased assets are of a specialised nature such that only the institution can use the assets without modifications being made;  The lessor’s losses associated with cancellation of the lease by the lessee is borne by the lessee; or  The leased assets cannot easily be replaced by another asset.6.4 Transactions and other events are accounted for and presented in accordance with their substance and financial reality and not merely with legal form. While the legal form of a lease agreement is that the lessee may acquire no legal title to the leased asset, in the case of finance lease the substance and financial reality are that the lessee acquires the economic benefits or service potential of the use of the leased asset for the obligation to pay for that right an amount approximating to the fair value of the asset and the related finance charge.6.5 Sometimes the terms of a lease is such that the lessee is substantially in the same economic position as if the lessee had borrowed money to buy the asset (even though legal title may not pass to the lessee). For example, this may be the case if the lease payments effectively are paying for the whole asset or if the lease term is such that the lessee can use the asset for the major part of its economic life.32 | P a g e
  • 7. CLASSIFICATION OF A LEASE AGREEMENT Yes Ownership transferred at end of lease? No Bargain purchase option? Yes No Lease term = major part of economic life? Yes No Present value of minimum lease payment > Yes fair value of asset? No FINANCE LEASE OPERATING LEASE8. ACCOUNTING POLICY8.1 Operating and finance lease commitments are expensed when the payments aremade. Assets acquired in terms of finance lease agreements are disclosed in the annexures and disclosure notes to the Financial Statements.8.2 The classification of the lease (i.e. operating or finance lease) must be made at the inception of the lease agreement and accounted for as follows:33 | P a g e
  • Item Segment Asset Segment Project segmentOperating leaseOPERATING LEASE LEASES: PHOTOSTAT MACHINES NO PROJECTS (STAND ALONE ITEM) CUR LEASES: FAX MACHINESFinance leaseFINANCE LEASE LEASES: CELLPHONES NO PROJECTS (STAND ALONE(Capital portion of ITEM) CAPinstalments) LEASES: TELEPHONE SWITCHES LEASES: MEDICAL EQUIPMENT LEASES: NON-MEDICAL EQUIPMENTInterest on leasesINTEREST ON LEASES LEASES: CELLPHONES NO PROJECTS (STAND ALONE ITEM) CUR(interest portion of LEASES: TELEPHONE SWITCHESinstalment LEASES: MEDICAL EQUIPMENT LEASES: NON-MEDICAL EQUIPMENT8.3 Unfortunately the PFMA prohibits borrowing by National/Provincial Departments and the Treasury Regulations makes it clear that finance leases are deemed to be borrowings and are therefore not permitted.8.4 Although departments are not permitted to enter into/have finance leases, all finance leases that they do have should be disclosed as finance leases. It will however mean that the department will not be complying with the Treasury Regulations (TR 13). Finance leases may not (incorrectly) be disclosed as operating leases even when the lease is condoned by National Treasury.8.5 Practice Note 5 of 2007/08 issued by the Office of the Accountant General seeks to provide the following circumstances where departments may enter into finance leases without additional approval required:8.5.1 Finance leases where:  A Finance lease is more economical than an operating lease; and  The period of the finance lease does not exceed 60 months in respect of motor vehicles and 36 months for equipment except with written approval by the relevant Treasury; and  The finance lease was entered into in terms of RT3 of 2006 or a transversal contract entered into by National Treasury34 | P a g e
  • 8.5.2 Blanket approval for any irregular expenditure incurred as a result of RT3 of 2000 and RT3 of 2003 Transversal contracts entered with various suppliers for the supply, delivery, installation, commissioning and maintenance of office equipment and labour saving devices has been given9. PROCEDURES TO BE FOLLOWED BY DIRECTORATES/DISTRICTS AND INSTITUTIONS WITH REGARD TO THE CLASSIFICATION AND ACCOUNTING OF LEASES9.1 MAINTENANCE OF SEPARATE LEASE REGISTERS FOR FINANCE AND OPERATING LEASES AND THE CLASSIFICATION OF LEASES:9.1.1. Directorates/Districts and Institutions must ensure that all leases concluded be identified and classified.9.1.2. The following serves as examples of Operating and Finance Leases determined from lease agreements currently in place. Finance Leases Operating Leases Cell phone contracts where the Photostat machines department holds the contract Telephone Switchboard Agreements Fax machines Equipment Lease Agreements These agreements are sometimes known as hire purchase agreements where it was clear from the outset that the asset will remain with the department for most of its economic life and the only reason why it was not outright purchased was because it was deemed more economical and affordable to pay the purchase price over a fixed period. Also in cases where assets are almost permanently placed with Departments with the written arrangement that Departments will buy dedicated consumables to be used on the equipment. If there is a fixed portion paid for the availability of the equipment and even possibly a fixed amount for consumables per month, the fixed amount for the asset will be the lease and that for the consumables will be a normal commitment while the variable35 | P a g e
  • amount for the consumables at a unit price will be normal expenditure. If there is no charge for the asset being placed on the premises there is no lease. It must be noted that the terms of the agreement will dictate whether an Operating or Finance Lease has been concluded. If in doubt kindly approach the SCM Unit at Head Office for assistance.9.1.3 Leases concluded must be entered into a Lease Register. Separate Lease registers must be maintained for Operational and Finance Leases. Each Lease register must contain the minimum requirements as per paragraph 6 of Treasury Circular 5/ 2006 dated 10 March 2006 distributed under cover of Finance Instruction G19/ 2006 dated 13 April 2006.9.1.4 Information on leases concluded and copies of the Lease Agreements must be forwarded to SCM: Section Contract Management, 4 Dorp Street, Cape Town on a monthly basis. An indication must also be given of the classification of the lease for audit purposes.9.1.5 The Section: Contract Management will also maintain a Lease Register and will ensure that the Register maintained at Head Office agrees with the Lease Register maintained by the Directorate/District/Institution.9.1.6 The rental of gas cylinders via National Contract RT 81 should not be considered as leases as the rental is payable annually in advance. If any other gases or containers are rented or leased on a basis where it is payable on a fixed monthly/ quarterly/ six-monthly basis, these arrangements should be measured against the criteria for leases.9.2 ACCOUNTING OF LEASES9.2.1 Leases must be accounted according to the new SCOA effective from 1 April 2008. All Operating Leases must be paid as follows: Item Segment Operating Leases Asset Segment Leases: Photostat Machines Leases: Fax Machines Project Segment No projects (stand-alone) current36 | P a g e
  • All Finance Leases to be paid as follows: Item Segment Financial Leases Asset Segment Leases: Cellphones Leases: Telephone Switches Leases: Medical Equipment Leases: Non-Medical Equipment Project Segment No projects (stand-alone) capital9.2.1.3 All interest payments on finance leases must be paid as follows: Item Segment Interest Paid: Finance Leases Asset Segment Leases: Cellphones Leases: Telephone Switches Leases: Medical Equipment Leases: Non-Medical Equipment Project Segment No projects (stand-alone) current9.2.2 At the end of the financial year i.e. from 1 – 15 April of each year the Section: Contract Management will obtain the relevant information on the Finance Lease payments made. A Journal where the interest portion will be shifted from capital to interest will be drawn by Head Office before 31 April of each year.Your co-operation is appreciated.MR JM JOOSTEpp HEAD: HEALTHDATE: 27 March 2009 Jooste/Fin InstructionG22/2009Classification of lease agreements in the SCOA/March 200937 | P a g e
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  • Western Cape - Dept of Health Capex Budget 2011 - 2016 Annual increase 5% 2011/2012 2012/2013 2013/2014 2014/2015 2015/2016 2016/2017 2017/2018 2018/2019 2019/2020 2020/2021 0 0 0 0 0 0 0 0 0 0 1. Allocation for low-value equipment and other assets 100 000 000 105 000 000 110 250 000 115 762 500 121 550 625 127 628 156 134 009 564 140 710 042 147 745 544 155 132 822 2. Allocation for big-ticket assets * 100 000 000 105 000 000 110 250 000 115 762 500 121 550 625 127 628 156 134 009 564 140 710 042 147 745 544 155 132 822 Budgeted Expenditure 200 000 000 210 000 000 220 500 000 231 525 000 243 101 250 255 256 313 268 019 128 281 420 085 295 491 089 310 265 643 Possible # Possible # Possible # Possible # Possible # Possible # of units of units of units of units of units of units * 6 units at 5 000 000 = 30 000 000 6 0 0 7 0 0 3 10 000 000 = 30 000 000 3 0 0 2 0 0 1 15 000 000 = 15 000 000 1 0 0 2 0 0 75 000 000 75 000 000 0 0 85 000 000 0 0 2011/2012 2012/2013 2013/2014 2014/2015 2015/2016 2016/2017 2017/2018 2018/2019 2019/2020 2020/2021 Cash Flows Annual Budget Per Year 100 000 000 105 000 000 110 250 000 115 762 500 121 550 625 127 628 156 134 009 564 140 710 042 147 745 544 155 132 822 Cumulative 100 000 000 205 000 000 315 250 000 431 012 500 552 563 125 680 191 281 814 200 845 954 910 888 1 102 656 432 1 257 789 254 Rental Cash Flows Per Year (17 601 918) (17 601 918) (17 601 918) (37 978 339) (37 978 339) (27 604 078) (27 604 078) (20 376 421) (8 366 917) (8 366 917) Cumulative (17 601 918) (35 203 837) (52 805 755) (90 784 094) (128 762 433) (156 366 511) (183 970 590) (204 347 010) (212 713 927) (221 080 844) Cash Differential Per Year 82 398 082 87 398 082 92 648 082 77 784 161 83 572 286 100 024 078 106 405 486 120 333 622 139 378 627 146 765 905 Cumulative 82 398 082 169 796 163 262 444 245 340 228 406 423 800 692 523 824 770 630 230 256 750 563 877 889 942 505 1 036 708 409 less: (assets not rented) (25 000 000) (26 250 000) (27 562 500) (28 940 625) (30 387 656) (31 907 039) (33 502 391) (35 177 511) (36 936 386) (38 783 205) 0.25 Available Cash: Per Year 57 398 082 61 148 082 65 085 582 48 843 536 53 184 630 68 117 039 72 903 095 85 156 111 102 442 241 107 982 699 Cumulative 57 398 082 118 546 163 183 631 745 232 475 281 285 659 910 353 776 949 426 680 044 511 836 155 614 278 397 722 261 096 Accelerated equipment purchases: 2011/2012 13 4 units at 5 000 000 = 20 000 000 2 units at 10 000 000 = 20 000 000 P A G E 1 units at 15 000 000 = 15 000 000 55 000 000 Accelerated equipment purchases: 2014/2015 5 units at 5 000 000 = 25 000 000 1 units at 10 000 000 = 10 000 000 1 units at 15 000 000 = 15 000 000 50 000 000ANNEXURE F: TABLE 1: OPERATING LEASING BENCHMARK SCENARIO MODEL
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