Public related many activities/ services around the world are being given to private entities to build and operate and after certain point of time (depending upon the contractual arrangements between the parties) it is being handed over back to the entity (generally known as Grantor) who initially requested.
Usually these kind of arrangements are normally initiated by local government which direct to the private entity generally in relation to infrastructure or other essential areas e.g . generation of electricity/ power etc.
Under the current accounting practice in India, there is nothing specific relating to these type of contract/s which can talk about an appropriate accounting treatment in relation to the recognition and measurement & presentation of such instances.
After the applicability of IFRS/ IND-AS there is a specific section defined in Appendix-A of IND-AS-11 which talks about “service concession arrangements” and describes how to deal with these type of situations and its accounting treatments accordingly.
Below are summarized (although practical) flavor of the standard so that one can navigate and use it further as per the requirements –
1- First important thing to note that this standard will only be applicable in case of Operator (who has got this right to use or control some assets (whether given by grantor or purchased from third party) to provide certain services as directed,
2- Under IND-AS there is a word “right to use” of specified assets, which deals/ indicates that it could be kind of leasing arrangement rather what we do in current accounting where we do not account for such leasing arrangements, however the standard says that if the arrangement falls or going to fall under Leasing arrangement (as per Appendix C of IND-AS 17 “leases” where separate detailed analysis will soon be published for you reading) then if the conditions are satisfied to fall within this standard then Appendix A of IND-AS -11 “service concession will prevail and it would be appreciated to note that if we analyze it very carefully then we can argue that IND-AS 17 “leases” conveys right to control an asset whereas in this “service concession arrangement” grantor keeps right to control assets,
3- Now, to fall under the “Service concession arrangement” there must be a contractual arrangement which talks about THREE important things
a) WHAT services to be provided,
b) To WHOM to be provided,
c) At WHAT price it is be provided, AND
Grantor keeps the beneficial entitlement on these assets by returning either assets or any residual interest in these assets.
4- To be more specific, the Grantor wants to control prices (usually in case of electricity rates notified by official notification) and the target buyers to whom Operator needs to sell/ provide these services and at the end of the life of the project these should be handed over back to the Grantor (which usually be local government),
5- Now, there could be several clauses which can talk about the structure of the arrangement to be fulfilled but we broadly bifurcate this into TWO parts which will either be FINANCIAL ASSET or INTANGIBLE ASSET (against these rights which have been given to the Operator) to be shown in the books of account of Operator,
6- There are many situation where grantor does not require the operator to perform and significant constructions etc but it has given access to use the same to provide such services to public and then Operator can charge it from the users,
7- Residual value will be another determining factor which says that it should be returned to the Grantor, which essentially ensured that there is a handover of the value of remaining assets, if any. In general practice the life of the assets received from Grantor will have major useful life and hence there would be no residual life remaining at the end of the contract,
8- Now, the major accounting issue comes how to deal with these assets/ infrastructure which Operator receives from Grantor and its accounting in the books. Operator can not show these assets under Property, Plant and Equipment however in the current accounting practices it is being shown under Fixed assets only in India without giving any effect of the mentioned accounting treatments. There is further analysis which can be discussed as follows-
a) Operator now will have either a “Fixed Assets” or just a “Right to operate” on behalf of Grantor which will be having some value underlying,
b) To evaluate the value of right, Operator will need to assess based on its revenue or construction which is projected for future generation of revenue and based on these projection a fair value can be draw down which will be the value of the right to operate under this arrangements,
c) Now, if the Operator has Unconditional right to receive cash from Grantor irrespective of Operator output/ sale then it will be recognized as FINANCIAL ASSETS (as described in IND-AS 109) or if Operator merely has got right to charge public and based on that it will be recovered from Grantor, then it will be treated as INTANGIBLE ASSETS,
d) To simplify the above one can understand that if the grantor says it will pay charges irrespective of demand comes to the Operator then the Operator can recognize FINANCIAL ASSETS or else it will be INTANGIBLE ASSETS
e) It means that If the operator receives an intangible asset, then the total revenue recognized by the operator over the concession term exceeds the total cash received by the operator over the concession term. This is because the revenue recognized by the operator includes construction revenue for which the consideration received is non-cash – i.e. an intangible asset,
f) There could generally be some clause in the arrangement which require certain obligation to be fulfilled while restoring the asset which should be dealt as per IND-AS -37 accordingly,
g) Financial assets will then be account as per the relevant standard and Intangible asset will then be amortized based on expected useful life
After the applicability of this standard, an entity might end up transferring its initially recognized Fixed Assets to Intangible or financial assets and accordingly its depreciation will then be shown as amortization of Intangible assets.
A reader will appreciate about the main objective of the standard and an approach which one can follow while keeping in mind the basis of origin of such requirements. There could possibly be some specific situations or circumstances where the interpretation of any standard will be different as we should always keep in mind that IND-AS is principle based standards and lot more areas need management judgment in line with the standards relevant interpretation and best practices.
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