Service Concession Agreement

8/2/2019 Service Concession Agreement

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Exposure DraftGuidance Note on Accounting for Service

Concession ArrangementsCONTENTS Paragraphs

INTRODUCTION 13

SCOPE 49

ACCOUNTING 1027

EFFECTIVE DATE 28

TRANSITIONAL PROVISIONS 29-30

DISCLOSURE REQUIREMENTS 31-34

APPENDICES

I Application Guidance

II Information Notes

1 Accounting framework for public-to-private servicearrangements

2 References to Accounting Standards that apply totypical types of public-to-private arrangements

ILLUSTRATIVE EXAMPLES


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Exposure DraftGuidance Note on Accounting for Service

Concession ArrangementsThe following is the Exposure Draft of the Guidance Note on Accounting for

Service Concession Arrangements, issued by the Accounting Standards Board of

the Institute of Chartered Accountants of India, for comments. The Board invites

comments on any aspect of this Exposure Draft. Comments are most helpful if

they indicate the specific paragraph or group of paragraphs to which they relate,

contain a clear rationale and, where applicable, provide a suggestion for

alternative wording.

Comments should be submitted in writing to the Secretary, Accounting Standards

Board, The Institute of Chartered Accountants of India, ICAI Bhawan, Post BoxNo. 7100, Indraprastha Marg, New Delhi 110 002, so as to be received not

later than November 10, 2008. Comments can also be sent by e-mail at

[email protected]@icai.org.

INTRODUCTION

1 Infrastructural facilities for public services such as roads, bridges, tunnels,prisons, hospitals, airports, dams, water distribution facilities, energysupply and telecommunication networks have traditionally beenconstructed, operated and maintained by the public sector and financedthrough public budget appropriation.

2 Governments have introduced contractual service arrangements to attractprivate sector participation in the development, financing, operation andmaintenance of such infrastructural facilities. The infrastructural facilitiesmay already exist, or may be constructed during the period of the servicearrangement. An arrangement within the scope of this Guidance Notetypically involves a private sector entity (an operator) constructing theinfrastructural facilities used to provide the public service or upgrading it

(for example, by increasing its capacity) and operating and maintainingthose infrastructural facilities for a specified period of time. The operatoris paid for its services over the period of the arrangement. Thearrangement is governed by a contract that sets out performancestandards, mechanisms for adjusting prices, and arrangements forarbitrating disputes. Such an arrangement is often described as a build-operate-transfer, a rehabilitate-operate-transfer or a public-to-privateservice concession arrangement.
mailto:[email protected]:[email protected]:[email protected]:[email protected]


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3 A feature of these service arrangements is the public service nature of the

obligation undertaken by the operator. Public policy is for the servicesrelated to the infrastructural facilities to be provided to the public,irrespective of the identity of the party that operates the services. The

service arrangement contractually obliges the operator to provide theservices to the public on behalf of the public sector entity. Other commonfeatures are:

(a) the party that grants the service arrangement (the grantor) is apublic sector entity, including a governmental body, or a privatesector entity to which the responsibility for the service has beendevolved.

(b) the operator is responsible for at least part of the management ofthe infrastructural facilities and related services and does not

merely act as an agent on behalf of the grantor.

(c) the contract sets the initial prices to be levied by the operator forutilisation of infrastructural facilities and regulates price revisionsover the period of the service arrangement.

(d) the operator is obliged to hand over the infrastructural facilities tothe grantor in a specified condition at the end of the period of thearrangement, for little or no incremental consideration, irrespectiveof which party initially financed it.

SCOPE

4 This Guidance Note gives guidance on the accounting by operators forpublic-to-private service concession arrangements.

5 This Guidance Note applies to public-to-private service concessionarrangements if:

(a) the grantor controls or regulates what services the operator mustprovide with the infrastructural facilities, to whom it must provide

them, and at what price; and

(b) the grantor controlsthrough ownership, beneficial entitlement orotherwiseany significant residual interest in the infrastructuralfacilities if remainng at the end of the term of the arrangement.

6 Infrastructural facilities used in a public-to-private service concessionarrangement for its entire useful life (whole of life assets) are within the


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scope of this Guidance Note if the conditions in paragraph 5(a) are met.Paragraphs A1A8 of Appendix I provide guidance on determiningwhether, and to what extent, public-to-private service concessionarrangements are within the scope of this Guidance Note.

7 This Guidance Note applies to both:

(a) infrastructural facilities that the operator constructs or acquires froma third party for the purpose of the service arrangement; and

(b) existing infrastructural facilities to which the grantor gives theoperator access for the purpose of the service arrangement.

8 This Guidance Note does not specify the accounting for infrastructuralfacilities that were held and recognised as property, plant and equipmentby the operator before entering the service arrangement. The

derecognition requirements in Accounting Standard (AS) 10, Property,Plant and Equipment1will apply in these cases.

9 This Guidance Note does not specify the accounting by grantors.

ACCOUNTING

10 This Guidance Note sets out general principles for recognising andmeasuring the obligations and related rights in service concession

arrangements. The issues addressed in this Guidance Note accordinglyare:

(a) treatment of the operators rights over the infrastructural facilities;

(b) recognition and measurement of arrangement consideration;

(c) construction or upgrade services;

(d) operation services;

(e) borrowing costs;

(f) subsequent accounting treatment of a financial asset and anintangible asset; and

(g) items provided to the operator by the grantor.

1 . AS 10 is under revision.


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Treatment of the operators rights over the infrastructuralfacilities

11 Infrastructural facilities within the scope of this Guidance Note should not

be recognised as property, plant and equipment of the operator becausethe contractual service arrangement does not convey the right to controlthe use of the public service infrastructural facilities to the operator. Theoperator has access to operate the infrastructural facilities to provide thepublic service on behalf of the grantor in accordance with the termsspecified in the contract.

Recognition and measurement of arrangement consideration

12 Under the terms of contractual arrangements within the scope of thisGuidance Note, the operator acts as a service provider. The operatorconstructs or upgrades infrastructural facilities (construction or upgradeservices) used to provide a public service and operates and maintainsthose infrastructural facilities (operation services) for a specified period oftime.

13 The operator should recognise and measure revenue in accordance withAccounting Standard (AS) 7, Construction Contracts and AccountingStandard (AS) 9, Revenue Recognition for the construction or upgradeand operating the services it performs. If the operator performs more thanone service under a single contract or arrangement, consideration

received or receivable should be allocated by reference to the relative fairvalues of the services delivered, when the amounts are separatelyidentifiable. The nature of the consideration determines its subsequentaccounting treatment. The subsequent accounting for considerationreceived as a financial asset and as an intangible asset is detailed inparagraphs 2326 below.

Construction or upgrade services

14 The operator should account for revenue and costs relating to constructionor upgrade services in accordance with AS 7.

Consideration given by the grantor to the operator

15 If the operator provides construction or upgrade services the considerationreceived or receivable by the operator should be recognised at its fairvalue. The consideration may be rights to:


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(a) a financial asset, or

(b) an intangible asset.

16 The operator should recognise a financial asset to the extent that it has an

unconditional contractual right to receive cash or another financial assetfrom or at the direction of the grantor for the construction services; thegrantor has little, if any, discretion to avoid payment, usually because theagreement is enforceable by law. The operator has an unconditional rightto receive cash if the grantor contractually guarantees to pay the operator(a) specified or determinable amounts or (b) the shortfall, if any, betweenamounts received from users of the public service and specified ordeterminable amounts, even if payment is contingent on the operator toensure that the infrastructural facilities meet specified quality or efficiencyrequirements.

17 The operator should recognise an intangible asset to the extent that itreceives a right (a licence) to charge users of the public service. A right tocharge users of the public service is not an unconditional right to receivecash because the amounts are contingent on the extent that the publicuses the service.

18 If the operator is paid for the construction services partly by a financialasset and partly by an intangible asset it is necessary to accountseparately for each component of the operators consideration. Theconsideration received or receivable for both components should berecognised initially at the fair value of the consideration received orreceivable.

19 The nature of the consideration given by the grantor to the operator shouldbe determined by reference to the contract terms and when it exists,relevant contract law.

Operation services

20 The operator should account for revenue and costs relating to operationservices in accordance with AS 92.

Contractual obligations to restore the infrastructural facilities to a specifiedlevel of serviceability

21 The operator may have contractual obligations it must fulfill as a conditionof its licence (a) to maintain the infrastructural facilities to a specified level

2 . AS 9 is under revision.


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of serviceability or (b) to restore the infrastructural facilities to a specifiedcondition before these are handed over to the grantor at the end of theservice arrangement. These contractual obligations to maintain or restoreinfrastructural facilities, except for any upgrade element (see paragraph14), should be recognised and measured in accordance with Accounting

Standard) (AS) 29, Provisions, Contingent Liabilities and ContingentAssets i.e. at the best estimate of the expenditure that would be requiredto settle the present obligation at the balance sheet date.

Borrowing costs incurred by the operator

22 In accordance with (AS) 16, Borrowing Costs, the borrowing costsattributable to the arrangement should be recognised as an expense in theperiod in which they are incurred unless the operator has a contractualright to receive an intangible asset (a right to charge users of the publicservice). In this case borrowing costs attributable to the arrangement

should be capitalized during the construction phase of the arrangement inaccordance with AS16.

Financial asset

23 AS 30, AS 31 and AS 32 apply to the financial asset recognised underparagraphs 16and 18, from the date this Guidance Note comes into force,irrespective of the effective date(s) of the aforesaid Accounting Standards.

24 The amount due from or at the direction of the grantor is accounted for inaccordance with AS 30 as:

(a) a loan or receivable;

(b) an available-for-sale financial asset; or

(c) if so designated upon initial recognition, a financial asset at fairvalue through profit or loss, if the conditions for that classificationare met.

25 If the amount due from the grantor is accounted for either as a loan orreceivable or as an available-for-sale financial asset, AS 30 requiresinterest calculated using the effective interest method to be recognised inthe statement of profit and loss.

Intangible asset


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26 Accounting Standard (AS) 26, Intangible Assets, applies to the intangibleasset recognised in accordance with paragraphs 17 and 18 of thisGuidance Note.

Items provided to the operator by the grantor

27 In accordance with paragraph 11, infrastructural facilities to which theoperator is given access by the grantor for the purposes of the servicearrangement are not recognized as property, plant and equipment of theoperator. The grantor may also provide other items to the operator thatthe operator can keep or deal with as it wishes. If such assets form part ofthe consideration payable by the grantor for the services, they are notgovernment grants as defined in AS 12. They are recognised as assets ofthe operator, measured at fair value on initial recognition. The operatorshould recognise a liability in respect of unfulfilled obligations it hasassumed in exchange for the assets.

EFFECTIVE DATE

28 An entity should apply this Guidance Note for annual periods beginning onor after 1 April 2009. Earlier application is permitted. If an entity appliesthis Guidance Note for a period beginning before 1 April 2009, it shoulddisclose that fact.

TRANSITIONAL PROVISIONS

29 Subject to paragraph 30, changes in accounting policies on application ofthis Guidance Note should be accounted for retrospectively and the effectthereof should be adjusted in the opening balance of revenue reservesand/or the balance of the statement of profit or loss.

30 If, for any particular service arrangement, it is impracticable for anoperator to apply this Guidance Note retrospectively, it should:

(a) recognise financial assets and intangible assets that existed at thestart of the accounting period in which this Guidance Note is applied;

(b) use the previous carrying amount of those financial and intangibleassets (however previously classified) as their carrying amounts as atthat date; and

(c) test financial and intangible assets recognised at that date forimpairment, unless this is not practicable, in which case the amountsshould be tested for impairment as at the start of the current period.


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DISCLOSURE REQUIREMENTS

31 All aspects of a service concession arrangement should be considered indetermining the appropriate disclosures in the notes. An operator should

disclose the following in each period:

(a) a description of the arrangement;

(b) significant terms of the arrangement that may affect the amount,timing and certainty of future cash flows (eg the period of theconcession, re-pricing dates and the basis upon which re-pricing orre-negotiation is determined);

(c) the nature and extent (eg quantity, time period or amount asappropriate) of:

(i) rights to use specified assets;

(ii) obligations to provide or rights to expect provision ofservices;

(iii) obligations to acquire or build items of property, plant andequipment;

(iv) obligations to deliver or rights to receive specified assets at

the end of the concession period;

(v) renewal and termination options; and

(vi) other rights and obligations (eg major overhauls); and

(d) changes in the arrangement occurring during the period; and

(e) how the service arrangement has been classified

32 An operator should disclose the amount of revenue and profits or lossesrecognised in the period on exchanging construction services for afinancial asset or an intangible asset.

33 The disclosures required in accordance with paragraph 31 of thisGuidance Note should be provided individually for each serviceconcession arrangement or in aggregate for each class of serviceconcession arrangements. A class is a grouping of service concession


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arrangements involving services of a similar nature (eg toll collections,telecommunications and water treatment services).

34 The following disclosures should also be made:

(1) The carrying amounts of each of the following categories, asdefined in AS 30, should be disclosed either on the face of thebalance sheet or in the Schedules and notes:

(a) financial assets at fair value through profit or loss, showingseparately those designated as such upon initial recognitionif the criteria prescribed by AS 30 are met.

(b) loans and receivables;

(c) available-for-sale financial assets;

(d) financial liabilities measured at amortised cost.

(2) Reclassification

If the entity has reclassified a financial asset as one measured:

(a) at cost or amortised cost, rather than at fair value; or

(b) at fair value, rather than at cost or amortised cost,

it should disclose the amount reclassified into and out of eachcategory and the reason for that reclassification (see paragraphs56-60 of AS 30).

(3) tems of income, expense, gains or losses

An entity should disclose the following items of income, expense,gains or losses either on the face of the financial statements or in

the schedules and notes:

(a) net gains or net losses on:

(i) financial assets or financial liabilities at fair valuethrough profit or loss, showing separately those onfinancial assets or financial liabilities designated assuch upon initial recognition;


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(ii) available-for-sale financial assets, showing separately

the amount of gain or loss recognised directly inequity during the period and the amount removedfrom equity and recognised in profit or loss for the

period;

(iii) held-to-maturity investments;

(iv) loans and receivables; and

(v) financial liabilities measured at amortised cost;

(b) total interest income and total interest expense (calculatedusing the effective interest method) for financial assets orfinancial liabilities that are not at fair value through profit or

loss;

(c) fee income and expense (other than amounts included indetermining the effective interest rate) arising from financialassets or financial liabilities that are not at fair value throughprofit or loss; and

(d) interest income on impaired financial assets accrued inaccordance with paragraph A113 of AS 30; and

(e) the amount of any impairment loss for each class of financialasset.

(4) An entity should disclose the methods and, when a valuationtechnique is used, the assumptions applied in determining fairvalues of each class of financial assets or financial liabilities. Forexample, if applicable, an entity discloses information about theassumptions relating to interest rates or discount rates.


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Appendix I

APPLICATION GUIDANCE

This appendix forms an integral part of the Guidance Note.

Scope (paragraph 5)

A1 Paragraph 5 of this Guidance Note specifies that infrastructural facilitiesare within the scope of the Guidance Note when the following conditionsapply:

(a) the grantor controls or regulates what services the operator mustprovide with the infrastructural facilities, to whom it must providethem, and at what price; and

(b) the grantor controlsthrough ownership, beneficial entitlement orotherwiseany significant residual interest in the infrastructuralfacilities if remaining at the end of the term of the arrangement.

A2 The control or regulation referred to in condition (a) above, could be bycontract or otherwise (such as through a regulator), and includescircumstances in which the grantor buys all of the output as well as thosein which some or all of the output is bought by other users. In applyingthis condition, the grantor and any related parties should be considered

together. If the grantor is a public sector entity, the public sector as awhole, together with any regulators acting in the public interest, should beregarded as related to the grantor for the purposes of this Guidance Note.

A3 For the purpose of condition (a), above, the grantor does not need to havecomplete control of the price: it is sufficient for the price to be regulated bythe grantor, contract or regulator, for example by a capping mechanism.However, the condition should be applied to the substance of theagreement. Non-substantive features, such as a cap that will apply only inremote circumstances, should be ignored. Conversely, if for example, acontract purports to give the operator freedom to set prices, but any

excess profit is returned to the grantor, the operators return is capped andthe price element of the control test is met.

A4 For the purpose of condition (b), the grantors control over any significantresidual interest should both restrict the operators practical ability to sellor pledge the infrastructural facilities and give the grantor a continuingright of use throughout the period of the arrangement. The residualinterest in the infrastructural facilities is the estimated current value of the


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infrastructural facilities as if these were already of the age and in thecondition expected at the end of the period of the arrangement.

A5 Control should be distinguished from management. If the grantor retainsboth the degree of control described in paragraph 5(a) and any significant

residual interest in the infrastructural facilities, the operator is onlymanaging the infrastructural facilities on the grantors behalfeventhough, in many cases, it may have wide managerial discretion.

A6 Conditions (a) and (b) together identify when the infrastructural facilities,including any replacements required (see paragraph 21), are controlledby the grantor for the whole of its economic life. For example, if theoperator has to replace part of an item of infrastructural facility during theperiod of the arrangement (eg the top layer of a road or the roof of abuilding), the item of infrastructural facility should be considered as awhole. Thus condition (b) is met for the whole of the infrastructural facility,

including the part that is replaced, if the grantor controls any significantresidual interest in the final replacement of that part.

A7 Sometimes the use of infrastructural facilities is partly regulated in themanner described in paragraph 5(a) and partly unregulated. However,these arrangements take a variety of forms:

(a) any infrastructural facility that is physically separable and capableof being operated independently and meets the definition of a cash-generating unit as defined in AS 28 should be analysed separatelyif it is used wholly for unregulated purposes. For example, thismight apply to a private wing of a hospital, where the remainder ofthe hospital is used by the grantor to treat public patients.

(b) when purely ancillary activities (such as a hospital shop) areunregulated, the control tests should be applied as if those servicesdid not exist, because in cases in which the grantor controls theservices in the manner described in paragraph 5, the existence ofancillary activities does not detract from the grantors control of theinfrastructural facilities.

A8 The operator may have a right to use the separable infrastructural facilitiesdescribed in paragraph A7(a), or the facilities used to provide ancillaryunregulated services described in paragraph A7(b). In either case, theremay in substance be a lease from the grantor to the operator; if so, itshould be accounted for in accordance with AS 19.


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Appendix II

Information Notes

1. Accounting framework for public-to-private service arrangements

This note accompanies, but is not part of, this Guidance Note.

The diagram below summarises the accounting for service arrangementsestablished by this Guidance Note.


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Does the grantor control or regulate whatservices the operator must provide with theinfrastructural facilities, to whom it must

provide them, and at what price?

Does the grantor control, through ownership,beneficial entitlement or otherwise, any

significant residual interest in theinfrastructural facilities if remaining at the

end of the service arrangement?

OUTSIDE THE SCOPE OF THE

GUIDANCE NOTE

SEE INFORMATION NOTE 2

Are the infrastructural facilities

constructed or acquired by the

operator from a third party for the

purpose of the service arrangement?

Or are the infrastructural facilities

used in the arrangement for its

entire useful life?

Are the infrastructural facilities

existing infrastructural facilities of

the grantor to which the operator is

given access for the purpose of theservice arran ement?

WITHIN THE SCOPE OF THE GUIDANCE NOTEOperator does not recognise infrastructural facilities as property, plant and

equipment or as a leased asset.

Does the operator have a

contractual right to

receive cash or other

financial asset from or at

direction of the grantor

as described in

paragraph 16?

Does the operator have

a contractual right to

charge users of the

public services as

described in paragraph

17?

OUTSIDE THE

SCOPE OF THE

GUIDANCE

NOTE

SEE

PARAGRAPH 27

Operator recognises a financial

asset to the extent that it has a

contractual right to receive cash

or another financial asset as

described in paragraph 16

Operator recognises an

intangible asset to the extent

that it has a contractual right

to receive an intangible asset

as described in paragraph 17

Yes

Yes

Yes

Yes

Yes Yes

No

No

No

No

No No


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2. References to Accounting Standards that apply to typical types of

public-to-private arrangements

This note accompanies, but is not part of this Guidance Note.

The table sets out the typical types of arrangements for private sectorparticipation in the provision of public sector services and providesreferences to accounting standards that apply to those arrangements.The list of arrangements types is not exhaustive. The purpose of the tableis to highlight the continuum of arrangements. It is not the GuidanceNotes intention to convey the impression that bright lines exist betweenthe accounting requirements for public-to-private arrangements.

Category Lessee Service provider Owner

Typicalarrangementtypes

Lease (egOperatorleasesasset fromgrantor)

Serviceand/ormaintenancecontract(specifictasks egdebtcollection)

Rehabilitate operate -transfer

Build -operate-transfer

Build -own -operate

100%Divestment/Privatisation/Corporation

Assetownership

Grantor Operator

Capitalinvestment

Grantor Operator

Demand risk Shared Grantor Operator and/orGrantor

Operator

Typicalduration

820 years 15 years 2530 years Indefinite (ormay belimited bylicence)

Residual

interest

Grantor Operator

Relevant AS AS 19 AS 9 This Guidance Note AS 10


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Illustrative Examples

These examples accompany but are not part of this Guidance Note.

Example 1: The grantor gives the operator a financial asset

Arrangement terms

1 The terms of the arrangement require an operator to construct a roadcompleting construction within two yearsand maintain and operate theroad to a specified standard for eight years (ie years 310). The terms ofthe arrangement also require the operator to resurface the road at the endof year 8the resurfacing activity is revenue-generating. At the end ofyear 10, the arrangement will end. The operator estimates that the costs itwill incur to fulfill its obligations will be:

Table 1.1 Contract costs

Year Rs.*

Construction services 1 500

2 500

Operation services (per year) 310 10

Road resurfacing 8 100

2 The terms of the arrangement require the grantor to pay the operator Rs.

200 per year in years 310 for making the road available to the public.

3 For the purpose of this illustration, it is assumed that all cash flows takeplace at the end of the year.

Contract revenue

4 The operator recognises contract revenue and costs in accordance withAS 7, Construction Contractsand AS 9, Revenue Recognition. The costsof each activityconstruction, operation and resurfacingare recognisedas expenses by reference to the stage of completion of that activity.

Contract revenuethe fair value of the amount due from the grantor forthe activity undertakenis recognised at the same time. Under the termsof the arrangement the operator is obliged to resurface the road at the endof year 8. In year 8 the operator will be reimbursed by the grantor forresurfacing the road. The obligation to resurface the road is measured atzero in the balance sheet and the revenue and expense are not


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recognised in the statement of profit and loss until the resurfacing work isperformed.

5 The total consideration (Rs. 200 in each of years 38) reflects the fairvalues for each of the services, which are:

Table 1.2 Fair values of the consideration received or receivable

Fair value

Construction services Forecast cost + 5%

Operation services + 20%

Road resurfacing + 10%

Effective interest rate 6.18% per year

6 In year 1, for example, construction costs of Rs. 500, construction revenueof Rs. 525 (cost plus 5 per cent), and hence construction profit of Rs. 25are recognised in the statement of profit and loss.

Financial asset

7 The amounts due from the grantor meet the definition of a receivable inAS 30, Financial Instruments: Recognition and Measurement. Thereceivable is measured initially at fair value. It is subsequently measuredat amortised cost, i.e., the amount initially recognised plus the cumulativeinterest on that amount calculated using the effective interest method

minus repayments.

8 If the cash flows and fair values remain the same as those forecast, theeffective interest rate is 6.18 per cent per year and the receivablerecognised at the end of years 13 will be:

Table 1.3 Measurement of receivable

Rs.

Amount due for construction in year 1 525

Receivable at end of year 1* 525

Effective interest in year 2 on receivable at the end ofyear 1 (6.18% Rs.525)

32

Amount due for construction in year 2 525

Receivable at end of year 2 1,082

Effective interest in year 3 on receivable at the end ofyear 2 (6.18% Rs.1,082)

67

Amount due for operation in year 3 (Rs.10 x (1 + 20%)) 12


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Cash receipts in year 3 (200)

Receivable at end of year 3 961

* No effective interest arises in year 1 because the cash flows are

assumed to take place at the end of the year.

Overview of cash flows, statement of profit and loss and balance sheet

9 For the purpose of this illustration, it is assumed that the operator financesthe arrangement wholly with debt and retained profits. It pays interest at6.7 per cent per year on outstanding debt. If the cash flows and fairvalues remain the same as those forecast, the operators cash flows,statement of profit and loss and balance sheet over the duration of thearrangement will be:

Table 1.4 Cash flows (Rupees)

Year 1 2 3 4 5 6 7 8 9 10 Total

Receipts - - 200 200 200 200 200 200 200 200 1,600

Contractcosts*

(500) (500) (10) (10) (10) (10) (10) (110) (10) (10) (1,180)

Borrowingcosts

- (34) (69) (61) (53) (43) (33) (23) (19) (7) (342)

Net inflow/(outflow)

(500) (534) 121 129 137 147 157 67 171 183 78

* Table 1.1 Debt at start of year (table 1.6) x 6.7%

Table 1.5 Statement of profit and loss (Rupees)

Year 1 2 3 4 5 6 7 8 9 10 Total

Revenue 525 525 12 12 12 12 12 122 12 12 1,256

Contractcosts

(500) (500) (10) (10) (10) (10) (10) (110) (10) (10) (1,180)

Financeincome*

- 32 67 59 51 43 34 25 22 11 344

Borrowingcosts

- (34) (69) (61) (53) (43) (33) (23) (19) (7) (342)

Net profit 25 23 - - - 2 3 14 5 6 78

* Amount due from grantor at start of year (table 1.6) 6.18%


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Cash/(debt) (table) 1.6 6.7%

Table 1.6 Balance sheet (Rupees)

End of

Year

1 2 3 4 5 6 7 8 9 10

Amountduefromgrantor*

525 1,082 961 832 695 550 396 343 177 -

Cash /(debt)

(500) (1,034) (913) (784) (647) (500) (343) (276) (105) 78

Netassets

25 48 48 48 48 50 53 67 72 78

* Amount due from grantor at start of year, plus revenue and financeincome earned in year (table 5), less receipts in year (table 1.4). Debt at start of year plus net cash flow in year (table 1.4).

10 This example deals with only one of many possible types ofarrangements. Its purpose is to illustrate the accounting treatment forsome features that are commonly found in practice. To make theillustration as clear as possible, it has been assumed that the arrangementperiod is only ten years and that the operators annual receipts areconstant over that period. In practice, arrangement periods may be muchlonger and annual revenues may increase with time. In such

circumstances, the changes in net profit from year to year could begreater.

Example 2: The grantor gives the operator an intangible asset (alicence to charge users)

Arrangement terms

11 The terms of a service arrangement require an operator to construct aroadcompleting construction within two yearsand maintain and

operate the road to a specified standard for eight years (ie years 310).The terms of the arrangement also require the operator to resurface theroad when the original surface has deteriorated below a specifiedcondition. The operator estimates that it will have to undertake theresurfacing at the end of the year 8. At the end of year 10, the servicearrangement will end. The operator estimates that the costs it will incur tofulfil its obligations will be:


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Year Rs.*


2 500

Operation services (per year) 310 10Road resurfacing 8 100

12 The terms of the arrangement allow the operator to collect tolls fromdrivers using the road. The operator forecasts that vehicle numbers willremain constant over the duration of the contract and that it will receivetolls of Rs. 200 in each of years 310.

13 For the purpose of this illustration, it is assumed that all cash flows takeplace at the end of the year.

Intangible asset

14 The operator provides construction services to the grantor in exchange foran intangible asset, ie a right to collect tolls from road users in years 310.In accordance with AS 26, Intangible Assets, the operator recognises theintangible asset at cost, ie the fair value of consideration transferred toacquire the asset, which is the fair value of the consideration received orreceivable for the construction services delivered.

15 During the construction phase of the arrangement the operators asset(representing its accumulating right to be paid for providing constructionservices) is classified as an intangible asset (licence to charge users ofthe infrastructural facilities). The operator estimates the fair value of itsconsideration received to be equal to the forecast construction costs plus5 per cent margin. It is also assumed that the operator, as per AS 16,capitalises the borrowing costs, estimated at 6.7 per cent, during theconstruction phase of the arrangement:

Table 2.2 Initial measurement of intangible asset

Rs.Construction services in year 1 (Rs.500 (1 + 5%)) 525

Capitalisation of borrowing costs (table 2.4) 34

Construction services in year 2 (Rs.500 (1 + 5%)) 525

Intangible asset at end of year 2 1,084


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Total expense recognised in thestatement of profit and loss

12 14 15 17 20 22 100


21 For the purposes of this illustration, it is assumed that the operatorfinances the arrangement wholly with debt and retained profits. It paysinterest at 6.7 per cent per year on outstanding debt. If the cash flows andfair values remain the same as those forecast, the operators cash flows,statement of profit and loss and balance sheet over the duration of thearrangement will be:


Year 1 2 3 4 5 6 7 8 9 10 Total

Receipts - - 200 200 200 200 200 200 200 200 1,600Contractcosts*

(500) (500) (10) (10) (10) (10) (10) (110) (10) (10) (1,180)

Borrowing costs

- (34) (69) (61) (53) (43) (33) (23) (19) (7) (342)

Netinflow/(outflow)

(500) (534) 121 129 137 147 157 67 171 183 78

* Table 2.1

Debt at start of year (table 2.6) 6.7%


Year 1 2 3 4 5 6 7 8 9 10 Total

Revenue 525 525 200 200 200 200 200 200 200 200 2,650

Amortisation - - (135) (135) (136) (136) (136) (136) (135) (135) (1,084)

Resurfacingexpense

- - (12) (14) (15) (17) (20) (22) - - (100)

Other

contractcosts

(500) (500) (10) (10) (10) (10) (10) (10) (10) (10) (1,080)

Borrowingcosts*

- - (69) (61) (53) (43) (33) (23) (19) (7) (308)

Net profit 25 25 (26) (20) (14) (6) 1 9 36 48 78

* Borrowing costs are capitalised during the construction phase Table 2.1


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End of Year 1 2 3 4 5 6 7 8 9 10

Intangible

asset

525 1,084 949 814 678 542 406 270 135 -

Cash/(debt)* (500) (1034) (913) (784) (647) (500) (343) (276) (105) 78

Resurfacingobligation

- - (12) (26) (41) (58) (78) - - -

Net assets 25 50 24 4 (10) (16) (15) (6) 30 78

* Debt at start of year plus net cash flow in year (table 2.4).

22 This example deals with only one of many possible types ofarrangements. Its purpose is to illustrate the accounting treatment for

some features that are commonly found in practice. To make theillustration as clear as possible, it has been assumed that the arrangementperiod is only ten years and that the operators annual receipts areconstant over that period. In practice, arrangement periods may be muchlonger and annual revenues may increase with time. In suchcircumstances, the changes in net profit from year to year could begreater.

Example 3: The grantor gives the operator a financial asset andan intangible asset

Arrangement terms

23 The terms of a service arrangement require an operator to construct aroadcompleting construction within two yearsand to operate the roadand maintain it to a specified standard for eight years (ie years 310). Theterms of the arrangement also require the operator to resurface the roadwhen the original surface has deteriorated below a specified condition.The operator estimates that it will have to undertake the resurfacing at theend of year 8. At the end of year 10, the arrangement will end. The

operator estimates that the costs it will incur to fulfil its obligations will be:


Year Rs.*


2 500

Operation services (per year) 310 10

Road resurfacing 8 100


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* Amount guaranteed by the grantor as a proportion of theconstruction services

Financial asset

28 The amount due from or at the direction of the grantor in exchange for theconstruction services meets the definition of a receivable in AS 30,Financial Instruments: Recognition and Measurement. The receivable ismeasured initially at fair value. It is subsequently measured at amortisedcost, ie the amount initially recognised plus the cumulative interest on thatamount minus repayments.

29 On this basis the receivable recognised at the end of years 2 and 3 will be:

Table 3.3 Measurement of receivable

Rs.Construction services in year 1 allocated to the financial asset 350


Construction services in year 2 allocated to the financial asset 350

Interest in year 2 on receivable at end of year 1 (6.18% Rs.350)

22


Interest in year 3 on receivable at end of year 2 (6.18% Rs.722)

45

Cash receipts in year 3 (see table 3.5) (117)


Intangible asset

30 In accordance with AS 26, Intangible Assets, the operator recognises theintangible asset at cost, ie the fair value of the consideration received orreceivable.

31 During the construction phase of the arrangement the operators asset(representing its accumulating right to be paid for providing constructionservices) is classified as a right to receive a licence to charge users of the

infrastructural facilities. The operator estimates the fair value of itsconsideration received or receivable as equal to the forecast constructioncosts plus 5 per cent. It is also assumed that the operator capitalizesborrowing cost as per AS 16, estimated at 6.7 per cent, during theconstruction phase:

Table 3.4 Initial measurement of intangible asset


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Rs.

Construction services in year 1 (Rs.500 x (1 + 5%) 33%) 175

Borrowing costs (interest paid in year 1 and 2 33%) seetable 3.7

11

Construction services in year 2 (Rs.500 x (1 + 5%) 33%) 175

Intangible asset at the end of year 2 361

32 In accordance with AS 26, the intangible asset is amortised over theperiod in which it is expected to be available for use by the operator, ieyears 310. The depreciable amount of the intangible asset (Rs.361including borrowing costs) is allocated using a straight-line method. Theannual amortisation charge is therefore Rs.361 divided by 8 years, ieRs.45 per year.

Contract revenue and costs

33 The operator provides construction services to the grantor in exchange fora financial asset and an intangible asset. Under both the financial assetmodel and intangible asset model, the operator recognises contractrevenue and costs in accordance with AS 7, Construction Contracts, ie byreference to the stage of completion of the construction. It measurescontract revenue at the fair value of the consideration receivable. Thus, ineach of years 1 and 2 it recognises in its statement of profit and lossconstruction costs of Rs.500 and construction revenue of Rs.525 (costplus 5 per cent).

Toll revenue

34 The road users pay for the public services at the same time as theyreceive them, ie when they use the road. Under the terms of thisarrangement the cash flows are allocated to the financial asset andintangible asset in proportion, so the operator allocates the receipts fromtolls between repayment of the financial asset and revenue earned fromthe intangible asset:

Table 3.5 Allocation of toll receipts

Year Rs.Guaranteed receipt from grantor 700

Finance income (see table 3.8) 237

Total 937

Cash allocated to realisation of the financial asset per year(Rs.937 / 8 years)

117

Receipts attributable to intangible asset (Rs.200 x 8 years 663


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Rs.937)

Annual receipt from intangible asset (Rs.663 / 8 years) 83

Resurfacing obligations

35 The operators resurfacing obligation arises as a consequence of use ofthe road during the operation phase. It is recognised and measured inaccordance with AS 29, Provisions, Contingent Liabilities and ContingentAssets, ie at the best estimate of the expenditure required to settle thepresent obligation at the balance sheet date.

36 For the purpose of this illustration, it is assumed that the terms of theoperators contractual obligation are such that the best estimate of theexpenditure required to settle the obligation at any date is proportional tothe number of vehicles that have used the road by that date and increases

by Rs.17 each year. The operator discounts the provision to its presentvalue in accordance with AS 29. The income statement charge eachperiod is:

Table 3.6 Resurfacing obligation (Rupees)

Year 3 4 5 6 7 8 Total

Obligation arising in year (Rs.17discounted at 6%)

12 13 14 15 16 17 87

Increase in earlier years

provision arising from passage oftime

0 1 1 2 4 5 13

Total expense recognised instatement of profit and loss

12 14 15 17 20 22 100


37 For the purposes of this illustration, it is assumed that the operatorfinances the arrangement wholly with debt and retained profits. It paysinterest at 6.7 per cent per year on outstanding debt. If the cash flows andfair values remain the same as those forecast, the operators cash flows,

income statement and balance sheet over the duration of the arrangementwill be:


Year 1 2 3 4 5 6 7 8 9 10 Total

Receipts - - 200 200 200 200 200 200 200 200 1,600

Contract (500) (500) (10) (10) (10) (10) (10) (110) (10) (10) (1,180)


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costs*

Borrowingcosts

- (34) (69) (61) (53) (43) (33) (23) (19) (7) (342)

Net inflow/(outflow)

(500) (534) 121 129 137 147 157 67 171 183 78

* Table 3.1 Debt at start of year (table 3.9) 6.7%


Year 1 2 3 4 5 6 7 8 9 10 Total

Revenue onconstruction

525 525 - - - - - - - - 1,050

Revenue

fromintangibleasset

- - 83 83 83 83 83 83 83 83 663

Financeincome*

- 22 45 40 35 30 25 19 13 7 237

Amortisation - - (45) (45) (45) (45) (45) (45) (45) (46) (361)

Resurfacingexpense

- - (12) (14) (15) (17) (20) (22) - - (100)

Constructioncosts

(500) (500) (1,000)

Othercontractcosts

(10) (10) (10) (10) (10) (10) (10) (10) (80)

Borrowingcosts (table3.7)

- (23) (69) (61) (53) (43) (33) (23) (19) (7) (331)

Net profit 25 24 (8) (7) (5) (2) 0 2 22 27 78

* Interest on receivable Table 3.1 In year 2, borrowing costs are stated net of amount capitalised in

the intangible (see table 3.4)


End of year 1 2 3 4 5 6 7 8 9 10

Receivable 350 722 650 573 491 404 312 214 110 -

Intangible 175 361 316 271 226 181 136 91 46 -


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asset

Cash/(debt)* (500) (1,034) (913) (784) (647) (500) (343) (276) (105) 78

Resurfacingobligation

- - (12) (26) (41) (58) (78) - - -

Net assets 25 49 41 34 29 27 27 29 51 78

* Debt at start of year plus net cash flow in year (table 3.7).

38 This example deals with only one of many possible types ofarrangements. Its purpose is to illustrate the accounting treatment forsome features that are commonly found in practice. To make theillustration as clear as possible, it has been assumed that the arrangementperiod is only ten years and that the operators annual receipts areconstant over that period. In practice, arrangement periods may be muchlonger and annual revenues may increase with time. In such

circumstances, the changes in net profit from year to year could begreater.

Example 4: Arrangements involving consideration paid by theoperator for acquiring the intangible asset

A government authority is planning to give rights to build, operate and maintain atoll road passing through a central location in a city. It is willing to provide to theoperator, the right to charge the users utilising the facility. As per a governmentestimate, due to the development projects upcoming in the nearby city, a lot of

employment opportunities would be generated and a lot of people would beshifting their base to this city. In the future years, it is estimated that this wouldgenerate high revenues.

The government plans to initiate a bidding process with a minimum bid price ofRs.100 Crore for grant of the service concession arrangement. In addition, thebidder would have to incur the cost of construction which would approximate toan amount of Rs.120 Crore.

What should be the treatment accorded to such construction paid for obtainingthe right to build, operate, maintain and charge the users for the toll plaza?

In this case, apart from the fair value of the construction services rendered, theamount that would be paid for obtaining the service concession contract shouldalso be considered for valuation of the intangible asset.

Service Concession Agreement

Documents

Transcript of Service Concession Agreement