ACCOUNTING BY OPERATOR OF SERVICE CONCESSION CONTRACT

Service Concession agreement

In service concession agreements operator agrees to render construction and maintenance services in return for a consideration of a fixed-amount(s) and / or right-to-collect tolls. The concession agreement normally will have the following components:

Rendering construction services (constructing new asset or restoring or upgrading an existing asset);
Rendering operation and maintenance services (ie maintaining an asset to a specified level of serviceability)
Restoration of asset to a specified condition before handing over to grantor..

The service concession agreement would not normally specify consideration for each of the above component separately. Then, how does one identify and value revenue for each component?

Further consideration in service concession agreements can be in the form of:

Fixed amounts to be paid during the period of concession agreement; and / or
Right to collect user fee (for using the asset) from users

How do we relate the consideration received above to various components of the service concession contract?

Guidance note on ‘Service concession agreements’ issued by ICAI which is based on IFRIC 12 gives answers to the above questions. Guidance note requires costs and revenues for:

Construction services to be accounted as per AS 7;
Operation and maintenance services to be accounted as per AS 9; and
Restoration of the asset to be accounted as per AS 29

One must have understood from above that accounting for ‘Service concession agreements’ is quite complex. Apart from the requirements of applying above referred ‘accounting standards’, there would be other AS 30 to be applied for financial asset recognized and AS 26 to be applied for ‘intangible asset’ recognized. Further there is concept of ‘fair value’ that has to be understood if consideration is received as ‘financial asset’.

Accounting for concession agreements can be discussed in two phases:

Accounting during construction phase of the asset;
Accounting post-construction ie during operation and maintenance of the asset

Accounting during construction phase of the asset:

Costs and revenues for construction services are recognsied in profit and loss account by reference to the stage of completion of contract at the reporting date. Normally costs can be easily identified and recognized in accounts for the period.

How does one identify and value ‘revenues’, to match the costs recognized for the period?

Guidance note states the revenues should be recognized at its ‘fair value’. What would be the fair value of revenues / consideration? The ‘fair value of the consideration’ would be the “costs to build asset plus normal profit margins (expected from a construction contract for a similar asset)”.

Accounting of consideration would be:

Revenues (P&L) Cr (Costs + normal proft margins)

Receivable / Intangible asset (BS) Dr

If consideration is received in the form of “fixed amounts”, then the “receivable” would fall within the definition of “financial asset” as defined by AS 30. Thus to extent consideration is receivable by way of ‘fixed amount(s) (ie cash or any other financial asset)’ from the grantor a ‘financial asset’ is recognized in accordance with AS 30, 31 and 32.

If a ‘financial asset’ is recognized, AS 30 requires ‘interest-revenue’ using effective interest method (on balance due at end of the period) to be recognized in the profit and loss account.

If consideration is received in the form of “right-to-charge-tolls/user-fee”, then the receivable would fall within the definition of ‘intangible asset’ as defined by AS 26. Thus the consideration to the extent receivable in the form “right-to-charge-tolls/user-fee” would be accounted as per AS 26.

If the operator has borrowed moneys to build the asset, how to treat the interest costs on borrowings?

If we look at AS 16 it states borrowing costs can be capitalized to the extent they are attributable to construction of a ‘qualifying asset’. ‘Financial asset’ would not be a qualifying asset, thus interest costs would be charged to profit and loss account in the period in which they are incurred. Whereas ‘intangible asset’ would be a qualifying asset and thus interest costs during construction period would be capitalsed by adding to ‘value of intangible asset’.

Accounting during post-construction phase of the asset:

Operator shall account for revenues and costs relating to the operation services to be accounted as per AS 9

Costs can be clearly identified and charged to proft and loss account for the period. How does one identify and value ‘revenues’ from operation services?

If consideration is receivable in the form of ‘financial asset’, revenues would be recognized at ‘fair value of consideration’ receivable in profit and loss account.

What would be ‘fair value of consideration’? It would be – costs of operations services + normal profit margins (receivable if it is only a maintenance contract).

If a ‘financial asset’ has been recognized, in accordance with AS 30 ‘interest revenue’ (at effective interest rate on balance due) would be recoginsed in the profit and loss account.

If consideration is receivable in the form of ‘intangible asset’, revenues can be clearly identified in form of ‘toll / user-fee’ collected from users of the asset. Thus actual toll collections for the period would be revenues for the period.

During construction-phase of asset, if consideration-receivable was ‘right-to-collect-tolls’, an ‘intangible asset’ was recognized. This asset would be amortised over the period in which the operator has the right to charge tolls. Thus against ‘toll revenues’ recognized matching costs would be amortisation of intangible asset in profit and loss account.

Accounting for restoration of asset to a specified level before handing over

Operator my have contractual obligations to maintain the asset to a specified level of serviceability or restore asset to a specified condition at the time of handing over. Such contractual obligations would be recognized in accordance with AS 29 ie at the best estimate of the expenditure required to settle the present obligation at the balance sheet date.

If consideration is a ‘financial asset’, the costs of above obligations and matching revenue would be recognized in the year in which costs are actually incurred. Costs would be measured on actual basis.

How does one measure matching consideration / revenue? Consideration would be the fair value of consideration receivable. Fair value of consideration receivable (ie value of financial asset) = costs of restoration services + normal profit margins (receivable if it is only a restoration contract)

If consideration is received as ‘intangible asset’, the costs of above obligations proportionately would be recognized from the year the revenue is recognized. Thus from the year ‘toll revenues’ are recognized, costs (of the above obligation) are recognized proportionately. The principle of ‘best estimate of the expenditure required to settle the present obligation at the balance sheet date’ is applied.

Disclosure requirements

The Guidance note requires extensive disclosure requirements with regards to;

All material aspects of ‘Service concession agreement’
Amount of revenue in form of ‘financial asset or intangible asset’ recognized in exchange for construction services
Financial asset recognized as per AS 30
Methods and assumptions used in determining the fair value of assets / liabilities.

Conclusion

Service concession contracts are rarely as simple as depicted above in the article. The article only attempts at discussing basic concepts; and practical application would require a careful study of the contract, guidance note and calls for careful professional judgment.

We should be seeing extensive use of PPP contracts in coming years as Indian economy picks up its growth rate, which would call for an expert knowledge of accounting concepts discussed above. One can refer financial statements, prepared in accordance with IFRS, of ‘Noida Toll Bridge’ for a model application of the above discussed principles.