Amyas Morse, head of the National Audit Office (NAO), said he had issued a qualified opinion on the grounds the MOD is ‘likely to have omitted a material value of leased assets and associated liabilities from its statement of financial position.’

‘I cannot quantify the impact of these omissions on the accounts with certainty because, as a result of its accounting policies, the department has not maintained the records, or obtained the information required to do so,’ Morse said.

In his explanation of his decision, Morse said he regarded the accounting requirements for lease type arrangements as ‘particularly relevant’ to the MOD, as it has to enter into strategic arrangements with certain contractors to procure specialist defence platforms on a non-competitive basis.

Such arrangements may provide for the exclusive, or near exclusive, use of industrial assets and capability that have only limited use for other customers. As a result, the MOD may end up controlling a significant majority of the outputs of a supplier’s assets.

‘An example is where shipyards are used exclusively on defence contracts and the pricing of the contract recognises this by allowing the contractor to recover fixed costs other than through market rate or unit cost pricing. These arrangements may be considered to contain the characteristics of a finance lease as defined by IAS,’ Morse said.

The NAO report says a review by the MOD has identified 25 contracts that demonstrate characteristics of a lease under IAS 17, Leases, of which eight were then assessed as being finance leases. If recognised, these would lead to assets with an estimated initial net book value (for seven of the eight contracts) of some £860m being recognised in the MOD’s statement of financial position.

The MOD has previously confirmed that compliance with the standard is possible for existing contracts, but says that in practice this would create significant challenges. There would be a need for changes in business systems and processes, as well as for wider interaction by the department with its supplier base to obtain the necessary asset and liability information.

In 2015-16 the MOD formally decided to improve compliance with IAS 17 for new single contracts impacting a single site, with effect from 2016-17. This is intended as a pilot approach, with the MOD saying it will review the results of this exercise during 2016-17 including consideration of whether it can be expanded further.

In its report, the NAO pointed out that the new standard IFRS 16 is currently deemed effective from 1 January 2019, although at this stage the timetable for its adoption in the public sector, along with the extent of any adaptations, has not yet been determined by the Treasury.

The audit watchdog says that if this standard is adopted and/or adapted, then in the future the MOD will have to adhere to these new requirements, and so should ensure these are considered as part of its pilot project.

According to its annual accounts, in 2015-16 the Departmental Group incurred £41.2bn of net operating costs and held assets of £136.7bn and gross liabilities of £29.3bn.

Ministry of Defence 2015-16 accounts are here.