Accounting by infrastructure companies

In the absence of sufficient elaboration, many companies executing BOT contracts have treated infrastructure as fixed asset rather than as an intangible or financial asset. Infrastructure not only forms a significant component of India’s economic activity but is also a major thrust area that can provide the necessary impetus for the double digit GDP growth. But unfortunately, the accounting guidance to account for infrastructure projects is insufficient and ambiguous.

Accounting for such Service Concession Arrangements is done in accordance with Indian Accounting Standard (Ind AS) 11 i.e. Construction Contracts.

In this article, the broad requirements of Ind AS 11 and a key tax implication are discussed.

Build-Operate-Transfer (BOT) Contracts

Infrastructure for public services such as roads, bridges, hospitals, airports, water distribution facilities, energy supply etc. constructed, operated and maintained by the public sector and financed through public budget appropriation. Arrangement involves a private sector entity (an operator) constructing, operating and maintaining the infrastructure. The operator is paid for its services over the period of the arrangement. Such an arrangement is often described as a ‘build-operate-transfer’, a ‘rehabilitate-operate-transfer’ or a ‘public-to-private’ service concession arrangement.

Public-to-private service concession arrangements if:

• Grantor controls services the operator must provide with the infrastructure and control over the price to be charged from the public;
• Grantor controls—through ownership, beneficial entitlement or any significant residual interest in the infrastructure at the end of the term of the arrangement.

Treatment of the operator’s rights over the infrastructure

Infrastructure shall not be recognised as property, plant and equipment of the operator because the contractual service arrangement does not convey the right of control to the operator.

Accounting model (consideration for services provided)

Which of the accounting models to apply –

Financial asset model (right to receive the consideration from the grantor) and Intangible asset model (right to receive cash flows from the users of those infrastructure services).

Financial asset:

• to the extent operator has an unconditional right to receive cash / financial asset from or at the direction of the grantor; or
• operator has an unconditional right to receive cash if the grantor contractually guarantees to pay:

(a) specified or determinable amounts or

(b) the shortfall (between amounts received from users of the service and specified amounts); or

• even if payment is contingent that infrastructure meets specified quality or efficiency requirements.

Intangible asset: to the extent that operator receives a right to charge users of the public service (not an unconditional right because the amounts are contingent on the extent that the public uses).

Example: Construction of hospital on public-to-private service concession agreement; terms of consideration: operator will receive from the grantor, depending on the actual occupancy at hospital. Grantor has not assured minimum occupancy to the operator.

Reply: Intangible asset (operator is bearing demand risk, amount depends on usage of infrastructure i.e., the right is not unconditional)

Deciding which model is applicable, can sometimes become very tricky – in that case, judgements will have to be applied.

Accounting under Financial asset model:

Financial asset is accounted for in accordance with Ind AS 109 i.e., initially to be measured at Fair value. Subsequent measurement:

• amortised cost; or
• fair value through OCI; or
• fair value through profit or loss.

If measured at: amortised cost or fair value through OCI, Ind AS 109 requires interest calculated using the effective interest method to be recognised in profit or loss (Refer example below).

Accounting under Intangible asset model:

Ind AS 38 applies to the intangible asset recognised and it says intangible assets has to be recognised at cost (i.e., fair value).

Subsequent measurement: operator should amortise the intangible asset over the period of the service concession agreement.

Further, amounts received from the usage of the services shall be recognised as revenue. This way, amount of revenue is being booked twice under Intangible asset model. Refer example, explaining twice booking of revenue, given at last of this article.

Contractual obligations to restore infrastructure to a specified level of serviceability:

The operator may have contractual obligations it must fulfil:

• maintain the infrastructure to a specified level of serviceability
• to restore the infrastructure to a specified condition before it is handed over to the grantor at the end of the service arrangement.

These contractual obligations (present obligation i.e., when it is not considered as a separate performance obligation) shall be accounted for in accordance with Ind AS 37 i.e., at the best estimate of the expenditure that would be required to settle the present obligation at the end of the reporting period.

Borrowing costs

Financial asset model: In accordance with Ind AS 23, borrowing costs attributable to the arrangement shall be recognised as an expense in the period in which they are incurred.

Intangible asset model: Borrowing costs attributable to the arrangement shall be capitalised during the construction phase of the arrangement in accordance Ind AS 23.

Items provided to the operator by the grantor:

Grantor may also provide other items to the operator that the operator can keep or deal with as it wishes. If such assets form part of the consideration payable by the grantor, they are not government grants as per Ind AS 20. Instead, they are accounted for as part of the transaction price as per Ind AS 115.

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(Republished with Amendments by Team Taxguru)