TAX IMPLICATIONS RELATED TO THE IMPLEMENTATION OF IC INTERPRETATION 12: SERVICE CONCESSION ARRANGEMENTS

Transcription

1 The Malaysian Institute of Certified Public Accountants TAX IMPLICATIONS RELATED TO THE IMPLEMENTATION OF IC INTERPRETATION 12: SERVICE CONCESSION ARRANGEMENTS Prepared by: Joint Tax Working Group on FRS

2 Contents 1 Introduction Background 1.2 Scope of IC Issues addressed in IC Effective date 1.5 Transition Scope of comments 2 3 Key changes under IC The MFRS/ FRS Regime Accounting implications 7 5 Current tax treatment before implementation of IC Tax issues and treatment under IC 12 based on existing law 9 7 Proposal 11 9 APPENDIX 1: Financial Asset Model APPENDIX 2: Intangible Asset Model 17 Page No.

3 1. INTRODUCTION 1.1 Background Governments have introduced contractual service agreements to attract private sector participation in the development, financing, operation and the maintenance of infrastructure for the public such as roads, bridges, tunnels, hospitals, airports, water distribution facilities, energy supply and telecommunication networks. Such infrastructure have traditionally been constructed, operated and maintained by the government and financed through public budget allocation. The purpose of the IC Interpretation 12 (IC 12) is to give authoritative guidance on issues that are likely to receive divergent or unacceptable accounting treatment in such service arrangements. 1.2 Scope of IC 12 (i) (ii) The scope of IC 12 typically covers a service arrangement which contractually requires a private sector entity (Operator) constructing an infrastructure to provide services to the public on behalf of the public sector entity (Grantor). IC 12 applies to public-to-private service concession agreements 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 controls through ownership, beneficial entitlement or otherwise any significant residual interest in the infrastructure at the end of the term of the arrangement or the infrastructure is used in a public-to-private service concession arrangement for its entire useful life. (iii) The IC 12 applies to both: (a) Infrastructure that the Operator constructs or acquires from a third party for the purpose of the service arrangement; and (b) Existing infrastructure to which the Grantor gives the Operator access for the purpose of the service arrangement. (iv) IC 12 specifies the accounting by Operators only and not Grantors. 1

4 1.3 Issues addressed in IC 12 The IC 12 sets out general principles on recognising and measuring the obligations and related rights in service concession arrangements. The issues addressed in IC 12 are: (a) Treatment of Operator s rights over the infrastructure; (b) Recognition and measurement of arrangement consideration; (c) Construction or upgrade services; (d) Accounting treatment of a financial asset and an intangible asset; (e) Operation services; (f) Borrowing costs; (g) Subsequent accounting treatment of a financial asset and an intangible asset; and (h) Items provided to the Operator by the Grantor. 1.4 Effective date Under MFRS framework, IC 12 is effective for annual periods beginning on or after 1 January Earlier application is permitted. However, the effective date and issuance date that contained in IC 12 is those of the IASB s and is inapplicable in the new MFRS framework since MFRS 1: First-time Adoption of Malaysia Financial Reporting Standards requirements 1 will be applied on 1 January Under FRS framework, IC 12 is applicable for annual periods beginning on or after 1 July Transition IC 12 is to be applied retrospectively unless it is impractical to do so. Where IC 12 is impractical to be applied retrospectively, the interpretation describes the method to be used to recognise the financial assets and intangible assets. 2. SCOPE OF COMMENTS The scope of the comments in this paper is confined to the interpretation to the FRS regime under IC 12 that give rise to tax implications. 1 MFRS 1 requires period information to be restated as if the requirements of MFRS s effective for annual period beginning on or after 1 January 2012 have been always been applied, except for certain exceptions and exemptions. This means that, in preparing its first MFRS financial statements, the first-time adopter of MFRS shall refer to the provisions contained in MFRS 1 on matters relating to transition and effective dates instead of those contained in respective MFRSs. 2

5 It is to be noted that IC 12 will only be applicable to concession arrangements that are within the scope of IC 12( refer to paragraph 1.2 above) which will include arrangements such as build-operate-transfer concession arrangements. As such, arrangements such as those involving leases e.g. build-lease-transfer, build-leasemaintain-transfer arrangements are scoped out of IC KEY CHANGES UNDER IC 12 Treatment of Operator s rights over the infrastructure 3.1 Infrastructure is NOT recognised as property, plant and equipment of the Operator because the contractual service arrangement does not convey the right to control the use of the public service infrastructure to the Operator. The Operator merely has access to operate the infrastructure on behalf of the Grantor, even though it may have wide managerial discretion. Recognition and measurement of the consideration 3.2 Under the terms of contractual arrangements within the scope of IC 12, the Operator acts as a service provider. The Operator, (i) constructs or upgrades infrastructure used to provide a public service; and (ii) operates and maintains that infrastructure for a specified period of time. 3.3 The nature of the consideration received determines its subsequent accounting treatment. Construction or upgrade of services 3.4 The Operator will account for revenue and costs relating to construction or upgrade services in accordance with MFRS 111/ FRS 111: Construction Contracts. The consideration received or receivable in respect of construction or upgrade services is to be recognised at its fair value. The consideration maybe rights to: - A financial asset; or - An intangible asset. 3.5 The Operator will recognise a financial asset to the extent that it has an unconditional contractual right to receive cash or another financial asset from the Grantor. For an intangible asset, on the other hand, the Operator will recognise such an asset to the extent that it receives a right (a licence) to 3

6 charge users of the public service. receive cash. This is not an unconditional right to 3.6 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 of the component. The consideration received or receivable for both components will be recognised initially at the fair value of the consideration received or receivable. Accounting treatment of financial asset 3.7 The financial asset model applies if Grantor contractually guarantees the payment of specified/determinable amounts or the shortfall, if any, between the amounts received from users and specified or determinable amounts. 3.8 MFRS 132/ FRS 132 Financial Instruments: Presentation, MFRS 139/ FRS 139 Financial Instruments: Recognition and Measurement and MFRS 7/ FRS 7 Financial Instruments: Disclosures shall be applied to the financial asset. 3.9 Financial assets should be initially recognised at fair value being the estimated present value of all future cash receipts discounted using the prevailing market interest rate for similar instrument with a similar credit rating (i.e. the Grantor s incremental borrowing rate). The amount due from or at the direction of the Grantor is accounted for in accordance with MFRS 139/ FRS 139 as: (a) a loan or receivable; (b) an available-for- sale financial asset;or (c) a financial asset at fair value through profit or loss, if so designated at initial recognition For subsequent measurement, if the amount due from the Grantor is accounted for either as a loan or receivable or an available-for-sale financial asset, interest income is added to the carrying value of the financial asset and recognised in profit or lossusing the effective interest rate method. Accounting treatment of intangible asset 3.11 The intangible asset is recognisedwhen it is probable that the Operator will earn revenue from its right to charge users and the cost of the intangible asset can be measured reliably. Where the intangible asset is acquired in exchange for a non-monetary asset or combination of monetary and nonmonetary asset, the cost of the intangible asset is measured at the fair value of the asset given up unless the fair value of the asset received is more clearly evident. For example, when the Operator receives the right to the intangible asset in exchange for providing construction services to the 4

7 Grantor, the fair value of the construction service will be more evident than the fair value of the intangible asset received Subsequent measurement of the intangible asset requires the application of MFRS 138/ FRS 138 Intangible Assets. The Standard requires an intangible asset to be amortised over the asset s expected useful life. Tolled roads 3.13 For service concession agreements involving tolled roads, accounting will be generally based on the intangible asset model. However, if the concession arrangement provides for the Grantor to guarantee any shortfall in toll collection, the concession arrangement will constitute a right to a financial asset. Examples of typical payment arrangements (i) Users pay the Operator Arrangements 1 Users pay Operator Amounts payable depend on usage of the infrastructure Grantor does not guarantee minimum amount to be paid to Operator 2 Users pay Operator Amounts payable depend on usage of the infrastructure Grantor guarantees that Operator s revenue will not fall below a specified level 3 Users pay Operator Grantor controls the unit prices (rates) that the Operator may charge users 4 Users pay Operator Grantor agrees to pay the Operator any shortfall between actual revenue and a fixed minimum amount Assets recognised by Operator Intangible asset Financial asset and intangible asset Financial asset right to receive a minimum amount of cash Intangible asset right to collect additional revenue from users Intangible asset Financial asset and intangible asset Financial asset right to receive a minimum amount of cash Intangible asset right to collect additional revenue from users 5

8 (ii) Grantor pays the Operator Arrangements 1 Grantor pays Operator Amounts payable depend on usage of the infrastructure Grantor does not guarantee minimum amount to be paid to Operator 2 Grantor pays Operator Amounts payable depend on usage of the infrastructure Grantor guarantees that Operator s revenue will not fall below a specified level 3 Grantor pays Operator a fixed amount Amounts payable do not depend on usage of the infrastructure 4 Grantor pays Operator a fixed amount Users pay Operator according to usage Assets recognised by Operator Intangible asset Financial asset and intangible asset Financial asset right to receive a minimum amount of cash Intangible asset right to collect additional revenue from users Financial asset Financial asset and intangible asset Financial asset right to receive fixed amount Intangible asset right to charge users Operation services 3.14 In respect of operation services, the Operator will account for revenue and costs in accordance with MFRS 118/ FRS 118 Revenue. Revenue is to be measured at the fair value of the consideration received or receivable for services provided. In determining the fair value of the total consideration to be allocated to the various services provided under the service concession arrangement, future cash receipts are discounted using rate of interest in accordance with MFRS 118/ FRS 118. Borrowing costs 3.15 Under MFRS 123/ FRS 123 Borrowing Costs, borrowing costs attributable to the arrangement will be recognised as an expense in the period in which they are incurred unless the Operator has a contractual right to receive an 6

9 intangible asset (a right to charge the users of the public service). In such a case, borrowing costs attributable to the arrangement shall be capitalised during the construction phase of the arrangement in accordance with MFRS 123/ FRS 123. In the case of a financial asset, borrowing costs are not capitalised. Recognition of maintenance obligation 3.16 Service concession arrangements often contain a contractual obligation: To perform certain maintenance or replacement services at certain intervals; or To maintain the infrastructure to a specified level of serviceability; and/or To restore the infrastructure to a specified condition before it is handed over to the Grantor at the end of the concession period The Operator recognises and measures contractual obligations to maintain and restore infrastructure in accordance with MFRS 137/ FRS 137 Provisions, Contingent Liabilities and Contingent Assets, except for any upgrade element of which the Operator should recognise revenue and costs in accordance with MFRS 111/ FRS 111. Items provided to the Operator 3.18 Infrastructure items given access to by the Grantor for the purpose of the service arrangement are not recognised as property, plant and equipment of the Operator. If such assets form part of the consideration payable by the Grantor for the services, they are not government grants as defined under MFRS 120/ FRS 120 Accounting for Government Grants. They are recognised as assets of the Operator measured at fair value on initial recognition. Examples of the financial asset model and the intangible asset model as per Appendix 1 and THE MFRS/ FRS REGIME ACCOUNTING IMPLICATIONS Currently, companies with service concession arrangements account for development costs as non-current assets and these are amortised on a straight-line basis. In the case of tolled roads, development expenditure, heavy repairs and other concession assets (such as toll equipment, toll operation computer hardware and 7

10 software, etc.) are treated as non-current assets. The development expenditure is stated at cost less accumulated amortisation and impairment losses. The development expenditure is amortised over the concession period using projected toll revenue. For the heavy repairs and other concession assets, the costs incurred are amortised on a straight line basis over the economic life of such works. Included in the Operator s development expenditure is resurfacing obligation which arises as a consequence of use of the road during the operating phase. The resurfacing obligations is recognised and measured as part of the development expenditure. With the introduction of IC 12, the nature of the consideration by the Grantor determines the accounting treatment, i.e. whether the rights of the Operator is to be recognised as a financial asset or an intangible asset. The following are key requirements under IC 12: (i) Infrastructure is not the PPE of the operator. (ii) Revenue and costs are recognised during the construction phase of the service concession arrangement. (iii) Recognition of revenue and costs during the operation phase. (iv) Borrowing costs in the intangible asset model are capitalised during the construction phase (v) Resurfacing obligations are recognised and measured by making a provision which is discounted to present value and charged to the profit or loss. 5. CURRENT TAX TREATMENT BEFORE IMPLEMENTATION OF IC 12 The construction costs incurred on the asset are treated as capital expenditure for tax purposes. In respect of the income recognition, it is noted that for tax purposes no income is recognised during the construction phase of the concession agreement. The income however will be recognised when payments are received/receivable from the Grantor and/or charges are received/receivable from users of the service/facility when the operation/maintenance phase commences. All amounts amortised to the income statement are disallowed for tax computation purposes. Operating revenue during the operation/maintenance phase, e.g. toll collection, is fully recognised and taxed when receivable/received. Borrowing costs are claimed on an incurred basis from the commencement of the of the business, i.e. during the construction phase. 8

11 With regards to Industrial Building Allowance (IBA) claims in respect of tolled roads, a claim can be made under paragraph 67A Schedule 3 of the Income Tax Act 1967 (ITA). Any heavy repairs expenditure incurred which is equivalent to an upgrade of the roads would also be eligible for IBA claim. Such expenditure incurred is capitalised in the accounts, hence for IBA claims purposes, a separate account must be kept. In addition, IBA is also available for buildings under the following privatisation projects: (i) Build-lease-transfer paragraph 67B Schedule 3 ITA (ii) Build-lease-maintain-transfer Income Tax (Industrial Building Allowance) (Building under Privatisation Project and Private Financing Initiatives) Rules However, it is to be noted that IC 12 does not apply to the above-mentioned projects. 6. TAX ISSUES AND TREATMENT UNDER IC 12 BASED ON EXISTING LAW Recognition of income during construction phase With the introduction of IC 12, from an accounting perspective the Operator will recognise either a financial asset or an intangible asset in the accounts. Revenue will be recognised according to MFRS 111/ FRS 111 during the stages of construction and MFRS 118/ FRS 118 during the operation and maintenance phase. Interest in the asset substantially belongs to the Grantor and hence, is not reflected in the accounts of the Operator. Under MFRS 111/ FRS 111, the Operator is considered to have earned the revenue from the construction of the asset throughout the construction phase and hence the recognition of income during that period. For tax purposes, the issue that arises is whether the income recognition should follow the accounting treatment. It must be borne in mind that, service concession arrangements, unlike normal construction contracts which receive progress payments at regular intervals throughout the construction period, are structured such that they receive payments either from the Grantor or from the user of the services/facility only upon completion of the asset, i.e. when operation/maintenance phase begins. In fact, an Operator under the service concession agreement is a service provider which includes the building of the asset/facility for the Grantor, operating and maintaining it before transferring it to the Grantor. Hence, the Operator in such an agreement is not carrying on a construction business. 9

12 From a tax perspective, as revenue for the Operator is only receivable/received upon completion of construction, i.e. when the operation phase begins as per the terms of the arrangement, strictly there is no debt owing by the Grantor during the construction phase. Hence, no income should be recognised during this phase for tax purposes as it not within the ambit of section 24(1) ITA. Recognition of income during operation/maintenance phase From an accounting perspective, the operating revenue will be recognised based on the fair value of consideration to be allocated to the various services provided under the service concession agreement. This means that the operating revenue attributable to the construction phase revenue which has already been recognised in the accounts must be excluded. From a tax perspective, since the operating revenue is receivable/received for a particular period, the revenue will be recognised and brought to tax during that period. Hence, tax adjustments are necessary when determining the amount of taxable income and separate records must be kept. Borrowing costs Borrowing costs which are capitalised during the construction phase should be claimable on an incurred basis from the commencement of the business as these are considered incurred under section 33(1) ITA. Resurfacing obligations Provisions made for resurfacing obligations are not a deductible expense and will be disallowed in the tax computation. However, actual resurfacing costs may qualify for IBA claims. MFRS 139/ FRS 139 Under the financial asset model of IC 12, the recognition criteria would be subject to MFRS 139/ FRS 139, which has its own set of tax implications (refer to Discussion Paper on MFRS 139/ FRS 139). Amortisation Under the intangible asset model, intangible assets will be amortised to the profit and loss account; amortisation charges are not tax deductible. 10

13 IBA In terms of IBA claims, there is no change between the current position and the position after IC 12 is adopted. As provided in the tax law, as long as the conditions for qualifying for IBA are fulfilled, the claim for IBA can be made. 7. PROPOSAL 7.1 Projects Under 1C 12 Recognition of income Currently i.e. before the implementation of IC 12, during the construction phase period of service concession arrangements, no income is recognised in the accounts. Accordingly the tax treatment follows and no income is taxed during the construction phase. With the implementation of IC 12, although from an accounting perspective, notional income is now attributed to the construction phase, it is proposed from a tax perspective, in the case of the intangible asset model, no income be recognised during the construction phase and that only upon the collection of charges from the users of the service/facility will income be recognised, i.e. when the operation/maintenance phase begins. Similarly for the financial asset model, income is to be recognised only when the payments are received from the Grantor. The proposal is made taking into consideration of the fact that the Operator is not in construction business but is in the business of a service provider as provided in the service concession arrangement. During the construction phase, in substance no income is receivable or received from the Grantor. Further, any attempt to tax the notional income as recognised in the accounts during the construction phase (where IC 12 is applicable), may cause hardship to the Operator due to cashflow problems. IBA It is to be noted that for tolled roads, as provided in Schedule 3, ITA 1967, the Operator is eligible to claim IBA upon completion of the tolled roads. Similarly under the build-lease-transfer and build-lease-maintain- transfer projects, the assets are deemed industrial buildings and allowances are available to the service concessionaires under Schedule 3 and the specific rules as mentioned above. Except for those assets, all other assets/facilities constructed by the Operator in any service concession agreements are not eligible for any form of relief for the capital expenditure incurred either in the form of deductions or capital allowances in the current legislation. It is proposed that such assets/facilities be also given similar allowances. 11

14 Borrowing costs As provided under section 33(1) ITA, borrowing costs should be available to the Operator on an incurred basis i.e. from the commencement of the construction phase. Based on the service concession agreement, the business of the Operator would have commenced at the beginning of the concession period i.e. from the commencement of the construction of the asset and which would be carried on up to the end of the concession period. This is based on the fact that under the concession agreement, the Operator is required to build, operate and maintain the asset before transferring the asset to the Grantor. If the above is not feasible, then consideration should be given to allow the interest expenses incurred during the construction phase to be capitalised as part of the capital expenditure of the facility for purposes of Schedule 3 allowances. It is to be noted that based on the above proposal the characterisation of the Operator s income for both accounting and tax purposes will not be aligned. Hence, administratively the Operator has to keep the relevant records and make the necessary adjustments for tax computation purposes. 7.2 Tax treatment of other privatisation projects and private financing initiatives This discussion paper focuses only on those projects scoped in IC 12 which are essentially build-operate-transfer projects. However it is to be noted that there are various other privatisation projects and private financing initiatives approved by the Public Private Partnership Unit in the Prime Minister s Department. Amongst others these may include projects such as, i. operate and maintain service provider ii. build-lease-transfer; iii. build-lease-maintain-transfer. When considering the proposals in this paper on the tax treatment for projects covered under IC 12, it is proposed that the tax authorities also review the tax treatment for all other privatisation and private financing initiatives and issue comprehensive guidelines on the applicable tax treatment. Although it may not be possible to envisage all possible service arrangements in view of the complexity of such arrangements, the guidelines could be available for the more common type of agreements with some room for issuance of a ruling on a case to case basis for those projects not captured in the guidelines. In a self-assessment regime, the guidelines will provide the much needed clarity and the certainty on the tax treatment for such projects that Operators of these concession agreements are seeking. 12

15 Appendix 1 FINANCIAL ASSET MODEL Example : The grantor gives the operator a financial asset Terms of the arrangement i. The terms of the arrangement require an Operator to construct a road and construction is to be completed within two years. The Operator is required to maintain and operate the road to a specified standard for eight years (i.e. year 3 to year 10). The terms of the arrangement also require the Operator to resurface the road at the end of year 8, the resurfacing activity is revenuegenerating. The arrangement will end at the end of year 10. The Operator estimates that the costs it will incur to fulfill its obligations will be: Table 1.1 Contract costs Year RM (million) Construction services Operation services (per year) Road resurfacing ii. iii. Under the terms of the arrangement, the Grantor is required to pay the operator RM200 million per year in years 3-10 for making the road available to the public. For the purpose of this illustration, it is assumed that all cash flows take place at the end of the year. 13

16 Appendix 1 Recognition of contract revenue and costs iv. The Operator recognises contract revenue and costs in accordance with MFRS 111/ FRS 111 Construction Contracts and MFRS 118/ FRS118 Revenue. The costs of each activity i.e. construction, operation and resurfacing are recognised as expenses by reference to the stage of completion of that activity. Contract revenue the fair value of the amount due from the Grantor for the activity undertaken is recognised at the same time. Under the terms of the arrangement the Operator is obliged to resurface the road at the end of year 8. In year 8, the Operator will be reimbursed by the Grantor for resurfacing the road. The obligation to resurface the road is measured at zero in the statement of financial positionand the revenue and expense are not recognised in the profit or loss until the resurfacing work is performed. v. The total consideration (RM200m in each of year 3-8) reflects the fair values 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 vi. In year 1, for example, construction costs of RM500m, construction revenue of RM525m (cost of plus 5 per cent), and hence construction profit of RM25m is recognised in the income statement (refer Table 1.5). Financial asset vii. The amounts due from the Grantor meet the definition of a receivable under MFRS 139/ FRS139 Financial instruments: Recognition and Measurement. The receivable is measured initially at fair value. It is subsequently measured at amortised cost, i.e. the amount initially recognised plus the cumulative interest on the amount calculated using the effective interest method minus repayments. 14

17 Appendix 1 viii. If the cash flows and fair values remain the same as those forecast, the effective interest rate is 6.18 per cent per year and the receivable recognised at the end of years 1-3 will be: Table 1.3 Measurement of receivable (RM million) RM(million) Amount due for construction in year Receivable at end of year 1 (a) 525 Effective interest in year 2 on receivable at the end of year 1 32 (6.18% x RM525million) Amount due for construction in year Receivable at end of year 2 1,082 Effective interest in year 3 on receivable at the end of year 2 67 (6.18% x RM1,082 million) Amount due for operation in year 3 (RM10 million x (1 + 20%)) 12 Cash receipts in year 3 (200) Receivable at end of year (a) 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 comprehensive income and statement of financial position ix. For the purpose of this illustration, it is assumed that the Operator finances the arrangement wholly with debt and retained profits. It pays interest at 6.7 per cent per year on outstanding debt. The Operator s cash flows, statement of comprehensive income and statement of financial positionover the duration of the arrangement will be: Table 1.4 Cash flows (RM million) Year Total Receipts ,600 Contract costs (a) (500) (500) (10) (10) (10) (10) (10) (110) (10) (10) (1,180) Borrowing costs (b) - (34) (69) (61) (53) (43) (33) (23) (19) (7) (342) Net inflow/ (outflow) (500) (534) (a) Table

18 Appendix 1 (b) Debt at start of year (table 1.6) x 6.7% Table 1.5 Statement of comprehensive income(rmmillion) Year Total Revenue ,256 Contract costs (500) (500) (10) (10) (10) (10) (10) (110) (10) (10) (1,180) Finance income (a) Borrowing costs (b) - (34) (69) (61) (53) (43) (33) (23) (19) (7) (342) Net profit (a) Amount due from Grantor at start of year (table 1.6) x 6.18%. (b) Cash/(debt) (table 1.6) x 6.7%. Table 1.6 Statement of financial position(rm million) End of year Amount due from 525 1, grantor (a) Cash/ (debt) (b) (500) (1,034) (913) (784) (647) (500) (343) (276) (105) 78 Net assets (a) Amount due from Grantor at start of year, plus revenue and finance income earned in year (table 1.5), less receipts in year (table 1.4). (b) Debt at start of year plus net cash flow in year (table 1.4). 16

19 INTANGIBLE ASSET MODEL APPENDIX 2 Example : The Grantor gives the Operator an intangible asset (a licence to charge users) Terms of the arrangement i. The terms of a service arrangement require the Operator to construct a road(completing construction within two years) and maintain and operate the road to a specified standard for eight years (ie. years 3-10). The terms of the arrangement also require the Operator to resurface the road when the original surface has deteriorated below a specified condition. The operator estimates that it will have to undertake the resurfacing at the end of year 8. At the end of year 10, the service arrangement will end. The operator estimates that the costs it will incur to fulfill its obligations will be: Table 2.1 Contract costs Year (RM million) Construction services Operation services (per year) Road resurfacing ii. iii. The terms of the arrangement allow the operator to collect toll from road users. The Operator forecasts that vehicle numbers will remain constant over the duration of the contract and that it will receive toll of RM200 million in each of years For the purpose of this illustration, it is assumed that all cash flows take place at the end of the year. 17

20 Intangible asset APPENDIX 2 iv. The Operator provides construction services to the Grantor in exchange for an intangible asset, ie. a right to collect toll from road users in years In accordance with MFRS 138/ FRS 138 Intangible Assets, the Operator recognises the intangible asset at cost, ie. the fair value of consideration transferred to acquire the asset, which is the fair value of the consideration received for the construction services delivered. v. During the construction phase of the arrangement the Operator s asset (representing its accumulating right to be paid for providing construction services) is classified as an intangible asset (licence to charge users of the infrastructure). The Operator estimates the fair value of its consideration received to be equal to the forecast construction costs plus 5 per cent margin. It is also assumed that, in accordance with MFRS 123/ FRS 123 Borrowing Costs, the operator capitalizes the borrowing costs, estimated at 6.7 per cent, during the construction phase of the arrangement: Table 2.2 Initial measurement of intangible asset RM (million) Construction services in year 1 (RM500 million x (1 + 5%)) 525 Capitalisation of borrowing costs (Table 2.4) 34 Construction services in year 2 (RM500 million x (1 + 5%)) 525 Intangible asset at end of year 2 1,084 vi. In accordance with MFRS 138/ FRS 138 Intangible Assets, the intangible asset is amortised over the period in which it is expected to be available for use by the Operator, i.e. year The depreciable amount of the intangible asset (RM1,084 million) is allocated using a straight-line method. The annual amortization charge is therefore RM1,084 million divided by 8 years, ie. RM135 million per year. 18

21 Construction costs and revenue APPENDIX 2 vii. The Operator recognises the revenue and costs in accordance with MFRS 111/ FRS111 Construction Contracts, ie. by reference to the stage of completion of the construction. It measures contract revenue at fair value of the consideration received or receivable. Thus in each of years 1 and 2 it recognises in its profit or loss construction costs of RM500 million, construction revenue of RM525 million (cost plus 5 per cent) and, hence, construction profit of RM25 million. Toll revenue viii. The road users pay when they use the road. The operator therefore recognises toll revenue when it collects the toll. Resurfacing obligations ix. The Operator s resurfacing obligation arises as a consequence of use of the road during the operating phase. It is recognised and measured in accordance with MFRS 137/ FRS 137 Provisions, Contingent Liabilities and Contingent Assets, ie. at the best estimate of the expenditure required to settle the present obligation at the end of the reporting period. x. For the purpose of this illustration, it is assumed that the terms of the Operator s contractual obligation are such that the best estimate of the expenditure required to settle the obligation at any date is proportional to the number of vehicles that have used the road by that date and increases by RM17 million (discounted to a current value) each year. The Operator discounts the provision to its present value in accordance with MFRS 137/ FRS 137. The charge recognised for each period in profit or loss is: Table 2.3 Resurfacing obligation (RM million) End of year Total Obligation arising in year (RM17 m discounted at 6%) Increase in earlier years provision arising from passage of time Total expense recognised in profit or loss

22 APPENDIX 2 Overview of cash flows, statement of comprehensive income and statement of financial position xi. For the purpose of this illustration, it is assumed that the Operator finances the arrangement wholly with debt and retained profits. It pays interest at 6.7 per cent per year on outstanding debt. If the cash flows and fair values remain the same as those forecasted, the Operator s cash flows, statement of comprehensive income and statement of financial positionover the duration of the arrangement will be: Table 2.4 Cash flows (RMmillion) Year Total Receipts ,600 Contract costs (a) (500) (500) (10) (10) (10) (10) (10) (110) (10) (10) (1,180) Borrowing costs (b) - (34) (69) (61) (53) (43) (33) (23) (19) (7) (342) Net inflow/ (outflow) (500) (534) (a) Table 2.1 (b) Debt at start of year (table2.6) x 6.7%. Table 2.5 Statement of comprehensive income(rmmillion) Year Total Revenue ,650 Amortisation - - (135) (135) (136) (136) (136) (136) (135) (135) (1,084) Resurfacing expense - - (12) (14) (15) (17) (20) (22) - - (100) Other contract Costs (500) (500) (10) (10) (10) (10) (10) (10) (10) (10) (1,080) Borrowing costs (a)(b) - - (69) (61) (53) (43) (33) (23) (19) (7) (308) Net profit (26) (20) (14) (6) (a) Borrowing costs are capitalized during the construction phase. (b) Table

23 Table 2.6 Statement of financial position(rm million) APPENDIX 2 End of year Intangible asset 525 1, Cash/(debt) (a) (500) (1,034) (913) (784) (647) (500) (343) (276) (105) 78 Resurfacing obligation - - (12) (26) (41) (58) (78) Net assets (10) (16) (15) (6) (a) Debt at start of year plus net cash flow in year (table 2.4). 21