Sanjay Vij

In recent years, public-private participation has gained momentum, whereby the public sector (or Government) is able to attract private sector (or operator) participation in order to provide infrastructure facilities for common public use, such as roads, bridges and airports. Globally, it is even common to construct and operate hospitals, water distribution facilities, energy supply, etc, under public-private participation. In accounting parlance, such arrangements are re ferred to as service concession arrangements.

In India, we have recently seen service concession agreements entered into for toll roads and airports. Under these arrangements, the private operator constructs the infrastructural asset/facility and maintains and operates the same for a specified term. At the end of the specified term, the constructed asset/facility is transferred to the public sector. The common characteristic of all service concession arrangements is that the operator receives a right and incurs an obligation to provide services.

Currently, there is no specific accounting guidance under Indian accounting standards for the service concession arrangements. Generally, infrastructure companies account for the infrastructure as part of their fixed assets at the construction cost and do not recognise any revenue during construction period.

Revenue is normally recognised for amount recoverable from public sector and/or amount recovered from the customers for use of the infrastructure only after the construction is complete. Further, there is no clarity or consistency regarding accounting for replacement and maintenance expenditure.

Towards standardisation

India’s proposed move towards convergence to International Financial Reporting Standards (IFRS) from 2011 will certainly bring about standardisation in the manner in which service concession agreements are accounted for as it offers detailed guidance in this regard, which has been set out hereunder. Recently, an Exposure Draft was laid down on the subject by the Institute of Chartered Accountants of India and is generally consistent with the IFRS.

The operator cannot recognise infrastructure as its own asset as the operator does not control the public service infrastructure but is merely a service provider. The operator recognises the revenue and costs relating to construction activity in accordance with guidance applicable to construction contracts. The consideration receivable for construction services is recognised at its fair value.

Two types of arrangements

There exist two types of service concession arrangements. In one, the operator receives a financial asset, i.e. an unconditional contractual right to receive cash or another financial asset from the government in return for constructing the public sector asset. In the other, the operator receives an intangible asset, i.e. no more than a right to charge for use of the public sector asset that it constructs. A right to charge users is not an unconditional right to receive cash because the amounts are contingent on the extent to which the public uses the service. The consideration received or receivable by the operator is recognised at its fair value.

Further, there could be arrangements wherein both the elements, i.e. financial asset and intangible asset, exist within a single contract. To the extent that the government has given an unconditional guarantee of payment for the construction of the public sector asset, the operator has a financial asset and to the extent that the operator has to rely on the public using the service in order to obtain payment, the operator has an intangible asset.

Level of serviceability

Most service concession agreements contain contractual obligations to maintain the infrastructure to a specified level of serviceability or to restore the infrastructure to a specified condition before it is handed back to the grantor at the end of the service arrangement. To the extent that the government specifically pays or guarantees payments for these services, they are considered a revenue generating activity and accounted for when the service is rendered. Otherwise, it will be a cost for the operator and provision will have to be accrued for such obligation at its present monetary value.

In case it is the policy of the operator to capitalise borrowing costs attributable to the construction of the assets, he will capitalise those costs during the construction phase of the arrangement only if the consideration received or receivable is an intangible asset.

In all other cases, borrowing costs are expensed as incurred; however, if a financial asset is recognised in respect of the construction services, that receivable will accrue interest during its life.

The above principles can be quite complex and would require professional judgment during practical application, and will involve use of valuation experts to arrive at fair values of various services rendered by the operator. It will significantly impact the manner in which the operators present their financial position and performance and also result in tax and regulatory issues. Therefore infrastructure companies need to be aware of these changes that IFRS will bring in 2011 and gear up for effective implementation.