What is Service Concession Arrangement
Aservice concession arrangementis anarrangementwhereby a government or other public sector body contracts with a private operator to develop (or upgrade), operate and maintain the grantor’s infrastructure assets such as roads, bridges, tunnels, airports, energy distribution networks, prisons or hospitals. Major service concession arrangement which is prominently used with Asian context is :
Build-own-operate-transfer (BOOT) arrangement, the entity owns the constructed infrastructure or public facility until the end of the arrangement, then transfers that ownership to the public sector entity.
A build-own-operate (BOO) arrangement differs from a BOOT arrangement in that the private sector entity does not transfer ownership of the constructed infrastructure or public facility to the public sector entity.
As per the Para 5 IFRIC 12 on Service Concession Arrangements, This Interpretation applies to public-to-private service concession arrangements if:
(a) 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
(b) the grantor controlsthrough ownership, beneficial entitlement or otherwiseany significant residual interest in the infrastructure at the end of the term of the arrangement.
The contract must be entered between Private and Public party out of which Grantor must be a public party to the contract and should have *control or regulates infrastructure in all aspects and have significant residual interest in the infrastructure at the end of the arrangement.
*Example Control or regulation is well defined on AG 2-6(Accounting Guideline) IFRIC 12 OR AG 1-8 Hongkong IFRIC For testing the control criteria in more detailed manner.
If all the above the condition get satisfied, we need to test whether right classify as a Financial Asset or intangible asset
As per Para 16-18 of Hongkong IFRIC 12, which defines the classification whether right classify as a financial asset or Intangible asset
- The operator shall recognize a financial asset to the extent that it has an unconditional contractual right to receive cash or another financial asset from or at the direction of the grantor for the construction services; the grantor has little, if any, discretion to avoid payment, usually because the agreement is enforceable by law. The operator has an unconditional right to receive cash if the grantor contractually guarantees to pay the operator (a) specified or determinable amounts or (b) the shortfall, if any, between amounts received from users of the public service and specified or determinable amounts, even if payment is contingent on the operator ensuring that the infrastructure meets specified quality or efficiency requirements.
17 The operator shall recognise an intangible asset to the extent that it receives a right (a licence) to charge users of the public service. A right to charge users of the public service is not an unconditional right to receive cash because the amounts are contingent on the extent that the public uses the service.
18 If the operator is paid for the construction services partly by a financial asset and partly by an intangible asset it is necessary to account separately for each component of the operators consideration. The consideration received or receivable for both components shall be recognized initially at the fair value of the consideration received or receivable.
Keyfactors: The determination of appropriate classification between financial asset and intangible asset is the evaluation of demand risk. Demand risk is risk that the demand or usage for the infrastructure asset will be greater or less than expected. If the revenue model of operator somehow directly or indirectly depends upon the demand factor then we need to classify right as an Intangible asset.
For example: In case Toll projects , where operator receives an unconditional right to charge users for the public service, Therefore same type of project recognize as a intangible Asset. Generally the Power project which has no link with public demand classified under Financial Asset
How it would affect the Indian Financial Statements:
Under the previous GAAP, The operator recognized infrastructure asset as a fixed asset and claiming the depreciation on the same. Further Operator does not recognize any revenue or profit/Loss on the construction of the project during construction Period.
As per IND-AS ,the operators do not have a right to control the use of infrastructure, due to which such assets should not be recognized as its property, plant and equipment. The operator acts as a service provider under the arrangement. It constructs/upgrades (construction service) the infrastructure used to provide public service, as well as operates and maintains (operation services) the same for a specified period. Hence, it will recognize and measure revenue arising from construction and operation services in accordance with Ind-AS 11
As on Transition period
First-time adoption Ind-AS standard requires the Appendix to be generally applied retrospectively. In such cases, the following treatment is applied:
- Derecognize its property, plant and equipment
- Recognize financial and intangible assets that existed at the date of transition
- Adjust the impact with the transitional reserve by Indian GAAP amounts as carrying amount at that date.
Major Challenges with Indian context
- Drastically changes in Top line (Revenue) on the Financial statements
- Calculation of Fair value of Asset and liabilities
How to charge tax on the service concession transaction is also a complicated exercise
This Article has been shared by CA Deepak Rathore.