Capital provided by risk- and revenue-sharing partnerships:

accounting issues Rolls Royce, the UK aero-engine maker, was criticised for some of its accounting policies in 2002. One area of controversy was its treatment of risk- and revenue-sharing partnerships (RRSPs). These are designed to help the company fund development of new jet engines, which are often costly and risky investments. Management explain in the notes to the 2001 accounts how the group accounts for them.

Risk- and revenue-sharing partnerships. From time to time the Group enters into arrangements with partners who, in return for a share in future programme turnover or profit, make cash or other payments in kind which are not expected to be refundable. Sums received are credited to other operating income and payments to partners are charged to cost of sales.

Many analysts challenge this accounting treatment. They argue that an RRSP is a source of financing and should be accounted for as such on the balance sheet. Some think it is equity capital; others claim it is a loan.

Rolls Royce’s management disagree. They maintain it has none of the features of a loan. ‘Is it repayable? No. Does it accrue interest? No. It has no attributes of a loan, which is why it is not treated as a loan,’ says Paul Heiden, the company’s then finance director.

RRSPs had a significant impact on Rolls Royce’s 2001 results. The group reported sales of £6,328 million (A10,206 million) and pre-tax profit (excluding exceptional items) of £422 million that year. The pre-tax profit figure was struck after crediting £126 million for RRSPs:

£m RRSPs – receipts (credited to ‘other operating income’) 239

– payments (charged to ‘cost of sales’) (113)

Net impact of RRSPs on pre-tax profit 126 Required Comment on the way Rolls Royce accounts for its RRSPs. Explain why its accounting treatment is –

or is not – correct, in your view. If you disagree with the company’s treatment, outline the way you think it should account for the RRSPs.

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