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Date:26^th July 2010	Compiled by: M Sathya Kumar
IFRIC 12 Introduction : Service concession arrangements apply to public-private partnerships for execution of infrastructure projects for i.e., roads, bridges, tunnels, etc. This interpretation will impact infrastructure companies in India once they converge their financial statements from April 1, 2011. This interpretation deals with accounting treatment to be followed by operator. This article will deal with the concept enshrined in this interpretation as well as accounting and disclosure norms to be followed by the operator. Considering increasing thrust given by the Government for Public-Private-Partnerships (PPP) for execution of infrastructure projects, this interpretation will govern accounting by operators in future. Service concession arrangements typically involve two parties, grantor (government or public sector entity) and operator (private sector entity). The operator constructs, upgrades, operates and maintains infrastructure for a specified period of time. The operator is paid for its services over the period of arrangement. Such arrangements are also known as Build-Operate- Transfer (BOT) projects, a rehabilitate-operate-transfer or a public-private concession arrangement. This interpretation applies only if the following two conditions are satisfied as provided in para 5 of this interpretation : The grantor controls or regulates what services the operator must provide with the infrastructure, to whom it must provide them and at what price. and The grantor controls — through ownership, beneficial entitlement or otherwise — any significant residual interest in the infrastructure at the end of the term of the arrangement. Accounting treatment : Revenue recognition : The operator shall account for revenue and costs relating to construction services and upgrade services in accordance with IAS 11 : Construction Contracts. The operator shall account for operation services in accordance with IAS 18 : Revenue Recognition. The contract revenue is measured at the fair value of the consideration receivable. Operator’s rights over the infrastructure : The arrangement does not convey the right to control the use of public infrastructure and therefore infrastructure cannot be recognised as plant property and equipment as per IAS 16. The operator has only access to operate the infrastructure in accordance with the terms of contract on behalf of the grantor. The assets provided by the grantor if form part of the consideration payable by the grantor, then the same will be recognised as plant property and equipment, measured at fair value at initial recognition. In this case, the operator shall also recognise a liability in respect of unfulfilled obligations it has assumed in exchange for assets. Consideration receivable — Intangible asset or financial asset ? This is one of the important accounting issues which has to be dealt with by the operator for consideration received or receivable for the performance of construction or upgrade services. This consideration received or receivable shall have to be recognised at fair value. However, the consideration may be rights to : § Financial Asset § Intangible Asset Financial Asset : The operator shall recognise a financial asset when it has an unconditional right to receive cash or other financial asset from or at the discretion of the grantor. The operator is said to have an unconditional right when the grantor guarantees determinable amount or meets shortfall, if any, between amounts received from users of public service and guaranteed determinable amount even if the payment is contingent on the operator, ensuring that the infrastructure meets specified quality or efficiency requirements (Para 16 of IFRIC 12). The operator shall classify the financial asset either as a loan or receivable, an available-for-sale financial asset or fair value through profit and loss account (Para 24 and 25 of IFRIC 12). Generally, the entity would classify the financial asset as a loan or receivable considering lesser complexity involved and measure the same at amortised cost using effective interest method in the profit or loss account. Intangible Asset : The operator shall recognise an intangible asset to the extent it receives a right (a licence) to charge the users of public service. The assets need to be recorded as per fair value of consideration receivable in accordance with IAS 38 : Intangible Assets. The operator has a licence to charge users of the public service and therefore meets the definition of an intangible asset. In this case, the revenue is conditional and bears demand risk, unlike a financial asset where operator is insulated from demand risk and guaranteed a sum of money (Para 17 of IFRIC 12). In case the operator is paid for construction services partly by a financial asset and partly by an intangible asset, it will be necessary to account for each separately and recognise the consideration received/receivable at fair value. This situation may arise if the government partly finances the project cost. Resurfacing obligations : The operator’s resurfacing obligation arises as a consequence of use of the road during the operating phase. It is recognised and measured in accordance with IAS 37 : Provisions, Contingent Liabilities and Contingent Assets i.e., at the best estimate of the expenditure required to settle the present obligation at the end of the reporting period (Para IE 19 of IFRIC 12). Borrowing costs : The operator generally requires huge capital commitment and has recourse to debt funds for execution of infrastructure projects. IAS 23 : Borrowing Costs permits borrowing costs to be capitalised as part of cost of qualifying asset to the extent they are directly attributable to its acquisition, construction or production until the asset is ready for intended use or sale. The intangible asset meets the definition of qualifying asset as licence to charge public for use of infrastructure takes a substantial time for construction and up-gradation. A financial asset does not meet the definition of qualifying asset and hence the borrowing costs are not capitalised and the same are expensed as and when incurred (Para 22 of IFRIC 12). Amortisation of Intangible asset : The operator requires to account for an intangible asset in accordance with IAS 38 : Intangible Assets. IAS 38 provides for number of amortisation methods i.e., straight-line method, the diminishing balance method and the unit of production method. The method selected should reflect expected pattern of consumption of the expected future economic benefits embodied in the asset and the same should be applied consistently from period to period, unless there is a change in the expected pattern of consumption of those economic benefits. Disclosure norms : SIC-29 governs disclosure norms for operator companies and specifies appropriate disclosure that needs to be provided in the notes. All aspects of a service concession arrangement shall be considered in determining the appropriate disclosures in the notes. An operator and a grantor shall disclose the following in each period (Para 6 and 6A of SIC-29) : a description of the arrangement; significant terms of the arrangement that may affect the amount, timing and certainty of future cash flows (e.g., the period of the concession, re-pricing dates and the basis upon which re-pricing or re-negotiation is determined); the nature and extent (e.g., quantity, time period or amount as appropriate) of : rights to use specified assets; obligations to provide or rights to expect provision of services; obligations to acquire or build items of property, plant and equipment; obligations to deliver or rights to receive specified assets at the end of the concession period; renewal and termination options; and other rights and obligations (e.g., major overhauls); changes in the arrangement occurring during the period; and how the service arrangement has been classified. An operator shall disclose the amount of revenue and profits or losses recognised in the period on exchanging construction services for a financial asset or an intangible asset. Relevant extract from published accounts : Illustrative Notes to Account from Consolidated Financials of Noida Toll Bridge Company Limited (NTBCL) where they applied the interpretation of IFRIC 12 : Service Concession Arrangements for the year ended 2009. The Company has prepared their financial statements in accordance with International Financial Reporting Standards (IFRS). Service Concession Arrangement entered into between X & Co, NTBCL and Grantor : A Concession Agreement entered into between the NTBCL, X & Co Limited and the New Okhla Industrial Development Authority, Government of Uttar Pradesh, conferred the right to the Company to implement the project and recover the project cost, through the levy of fees/toll revenue, with a designated rate of return over a period of 30 years concession period commencing from 30th December 1998 i.e., the date of Certificate of Commencement, or till such time the designated return is recovered, whichever is earlier. The Concession Agreement further provides that in the event the project cost with the designated return is not recovered at the end of 30 years, the concession period shall be extended by 2 years at a time until the project cost and the return thereon is recovered. The rate of return is computed with reference to the project costs, cost of major repairs and the shortfall in the recovery of the designated returns in earlier years. As per the certification by the independent auditors, the total recoverable amount comprises project cost and 20% designated return. NTBCL shall transfer the Project Assets to the New Okhla Industrial Development Authority in accordance with the Concession Agreement upon the full recovery of the total cost of project and the returns thereon. Revenue recognition — Operation services : Revenue is recognised to the extent that it is probable that the economic benefits will flow to the Group and the revenue can be reliably measured. Revenue comprises : Toll revenue : Toll revenue is recognised in respect of toll collected at the Delhi-Noida Toll Bridge and the attributed share revenue from prepaid cards. Licence fee : Licence fee income from advertisement hoardings and office premises is recognised on an accruals basis in accordance with contractual obligations. Service charges : Service charges are recognised on accrual basis in respect of revenue recovered for the various business auxiliary services provided to the parties. Recognition of Concession Agreement as an Intangible Asset : Basis of accounting for the service concession : The Group has determined that IFRIC 12 Service Concession Arrangement is applicable to the Concession Agreement and hence has applied it in accounting for the concession. The directors have determined that the intangible asset model in IFRIC 12 Service Concession Arrangements is applicable to the concession. In particular, they note that users pay tolls directly so the grantor does not have the primary responsibility to pay the operator. In order to facilitate the recovery of the project cost and 20% designated returns through collection of toll and development rights, the grantor has guaranteed extensions to the terms of the Concession, initially set at 30 years. The Group has received an ‘in-principle’ approval for development rights from the grantor. However the Group has not yet entered into any agreement with the grantor which would constitute an assurance from the grantor to facilitate the recovery of shortfalls. Management recognises that the development right agreement when executed will give rise to intangible assets in their own right. Disclosures for Service Concession Arrangement as prescribed under SIC-29 Service Concession Arrangements — Disclosure have been incorporated into the financial statements. Significant assumptions in accounting for the intangible asset : On completion of construction of the Delhi-Noida Toll Bridge (6th February 2001), the rights under the Concession Agreement have been recognised as an intangible asset, received in exchange for the construction services provided. Construction costs include besides others, expenditure incurred and provisions for outstanding capital commitments on the Ashram Flyover, which was significantly completed on the date of recognition of the intangible asset. This section of the bridge was commissioned on 30th October 2001. The intangible asset received has been measured at fair value of the construction services as of Rs. 5,338,586,459 as on the date of commissioning. The Group has recognised a profit of Rs.1,548,095,840, which is the difference between the cost of construction services rendered (the cost of the project asset of Rs.3,790,490,619) and the fair value of the construction services. The Directors have concluded that as operators of the bridge, they have provided construction services to NOIDA, the grantor, in exchange for an intangible asset, i.e., the right to collect toll from road-users during the Concession year. Accordingly, the Group has measured the intangible asset at cost, i.e., the fair value of the construction services as at 6th February 2001, the date of completion of construction and commissioning of the asset. Key assumptions used in establishing the cost of the intangible asset are as follows : Construction of the DND Flyway commenced in 1998 and was completed on 6th February 2001. The exchange of construction services for an intangible asset is regarded as a transaction that generates revenue and costs, which have been recognised by reference to the stage of completion of the construction. Contract revenue has been measured at the fair value of the consideration receivable. Hence in each of the years of construction, construction revenue has been calculated at cost plus 17.5% and the corresponding construction profit has been recognised through retained earnings. Management has capitalised qualifying finance expenses until the completion of construction. The intangible asset is assumed to be received only upon completion of construction. Until then, management has recognised a receivable for its construction services. The fair value of construction services have been estimated to be equal to the construction costs plus margin of 17.5% and the effective interest rate of 13.5% for lending by the grantor. The construction industry margins range between 15-20% and management has determined that a margin of 17.5% is both conservative and appropriate. The effective interest rate used on the receivable during construction is the normal interest rate which grantor would have paid on delayed payments. The intangible asset has been recognised on the completion of construction, i.e., 6th February 2001. The management considers that they will not be able to earn the designated return under the Concession Agreement over 30 years. The Company has an assured extension of the concession as required to achieve project cost and designated returns. An independent engineer had earlier certified the useful life of the Delhi-Noida Toll Bridge as 70 years. The intangible asset was being amortised over the same years on straight-line basis. Based on the independent professional experts’ advice obtained during the current year, the Company has re-estimated the life of the bridge to be of 100 years. The method of amortization of the intangible asset has also been changed during the current year from straight-line to unit of usage method. Maintenance obligations : Contractual obligations to maintain, replace or restore the infrastructure (principally resurfacing costs and major repairs and unscheduled maintenance which are required to maintain the Bridge in operational condition except for any enhancement element) are recognised and measured at the best estimate of the expenditure required to settle the present obligation at the balance sheet date. The provision is discounted to its present value at a pre-tax rate that reflects current market assessments of the time value of money and the risks specific to the liability. Development rights will be accounted for as and when exercised. Conclusion : Infrastructure companies were following different practices as regards accounting for service concession arrangements. However this interpretation will bring out uniformity in accounting practices to be followed by infrastructure companies. The key issues to be addressed are determination of fair value of consideration for construction services rendered, which requires proper valuation and income tax consequences. Article by Tejas J. Parikh , Chartered Accountant
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