Accounting update. A new approach to grantor accounting for public private partnerships

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1 May 2015 Accounting update At a glance Exposure Draft released on service concession arrangements from a government grantor perspective Represents a major shift in current accounting from a risk and reward to a regulation and control approach More service concession assets and liabilities will be recognised on balance sheets Service concession arrangements will generally be recognised earlier Exposure Draft is open for comment until 27 July 2015 Final Standard is expected in the first half of 2016 A new approach to grantor accounting for public private partnerships After significant consultation, the Australian Accounting Standards Board (AASB) has released an Exposure Draft (ED) ED 261: Service Concession Arrangements: Grantor (ED261). This sets out the requirements for grantors of service concession arrangements (SCAs). This proposed standard will result in a more consistent approach in the accounting for SCAs from the public sector perspective, including bringing on to the balance sheet a number of arrangements previously not recognised. Given the size of the projects to which these commonly relate, the implications to the financial reports of the public sector entities that undertake SCAs could be significant. Background A common role of government is to provide infrastructure for public services. There are many ways a government can do this, including via SCAs. Depending on the nature and scope of these arrangements, they can also be known as public private partnership (PPP) arrangements. A SCA generally involves an operator (a private sector entity) constructing a public infrastructure asset (service concession asset) and/or providing public services, such as operational and/or maintenance services on behalf of the grantor (public sector entity), for an agreed period. SCA structures - two types of payments In exchange for the construction of the asset and provision of services, the grantor promises consideration to the operator in the form of cash or another financial asset (financial liability model) or grants the operator a right to charge users of the asset and services (grant of a right to the operator model). Common examples of the financial liability model include prisons, schools and hospitals; whereas the latter model is more common with major tolled road projects.

2 Financial liability model Under this model, at the date of committing to the principal provisions of the arrangement, the estimated future periodic payments to which the operator will be entitled are allocated between a component related to the design and construction or upgrading of the asset and components related to the ongoing operation and/or maintenance of the asset. Grant of a right to the operator model Under this model, the government grants the operator the right to collect fees from users of the asset for a specified period of time, in return for which the operator constructs the asset and has the obligation to supply agreed upon services, including the maintenance of the asset for the period of concession. The operator typically leases land, and sometimes State works, from the government and constructs the required infrastructure. At the end of the concession period, the constructed facilities are normally returned to the government. Key components of the proposed standard for consideration Control a crucial concept Consistent with AASB Interpretation 12: Service Concession Arrangements (Interpretation 12) and IPSAS 32: Service Concession Arrangements: Grantor (IPSAS 32), the ED has adopted a control by regulation approach. Therefore, the concept of control is crucial to the recognition of service concession assets and their associated liabilities by grantors. The ED requires a service concession asset to be recognised by a government grantor when the following criteria are met: The grantor shall recognise an asset provided by the operator and an upgrade to an existing asset of the grantor as a service concession asset if it controls the asset. The grantor controls the asset if, and only if: The grantor controls or regulates what services the operator must provide with the asset, to whom it must provide them, and at what price. The grantor controls - through ownership, beneficial entitlement or otherwise - any significant residual interest in the asset at the end of the term of the arrangement. The grantor shall recognise an asset that will be used in a service concession arrangement for its entire useful life (a whole-of-life asset) if the conditions above are met. 1 The fundamental principle is that control of the underlying infrastructure asset is subject to the SCA. Control or regulation of what services the operator must provide with the asset, to whom it must provide them, and at what price, are collectively a means by which a grantor can exercise and demonstrate control of the substantial benefits of the service concession asset. The ED then clarifies that the grantor does not need to have complete control of the service concession asset s use and price; it is sufficient for the price to be regulated by the grantor, or a third-party regulator (e.g., by a capping mechanism). The critical factor being that the operator does not have complete discretion to determine pricing. However, the regulation does need to be specific to that asset. To illustrate, consider the following example extracted from the application guidance of the ED: A regulator of rail services may determine rates that apply to the rail industry as a whole. Depending on the legal framework in a jurisdiction, such rates may be implicit in the contract governing a service concession arrangement involving the provision of railway transportation, or they may be specifically referred to therein. However, in both cases, the control of the service concession asset is derived from either the contract or from the specific regulation applicable to rail services and not from the fact that the grantor is a public sector entity that is related to the regulator of rail service. 2 While it is considered the proposed standard will assist in achieving consistency in the accounting for, and increased recognition of, service concession assets, its application will not be without judgement. For instance, consider a service concession asset that is partly regulated and partly unregulated. In such circumstances, an entity will need to consider whether the unregulated services are separable or whether they are ancillary. There are however instances where this differentiation will not be clear. For example, a grantor may control prices charged to children and seniors at a sports facility but the amounts charged to adults are not controlled. The same facilities are being used by all, regardless of the amount they pay. Alternatively, price regulation could be controlled by the grantor for services provided at certain times of the day rather than different classes of user. In such cases, it will be a matter of judgement whether enough of the service is regulated in order to demonstrate that the grantor has control of the asset. 1 2 ED 261: Service Concession Arrangements: Grantor, paragraph 8 ED 261: Service Concession Arrangements: Grantor, paragraph AG 13 EY Page 2

3 Importantly, control will only be achieved when the grantor controls or regulates not only the price; but also controls the services the operator must provide with the assets and to whom they should be provided. Recognition and measurement considerations Service concession asset An important difference between the ED and current practice is that under the current risks and rewards approach, the asset is generally only recognised once it is ready for use (which is considered to occur at commercial acceptance). Under the ED, the grantor is likely to have to recognise the service concession asset (and related liability) from the beginning of the construction period to the extent that it controls the asset from this point. This may be earlier than current practice. The ED requires the grantor to initially recognise the asset at fair value unless the asset is an existing asset of the grantor. Subsequent to initial recognition, the service concession asset(s) is accounted for consistently with other similar owned assets and would be subject to depreciation and impairment. Liabilities Financial Liability Model Under this model, the grantor will recognise a financial liability for its obligation to pay cash (or another financial asset) to the operator when it recognises the service concession asset. This liability is initially measured at the same amount as the service concession asset and is accounted for as a financial instrument. Payments to the operator over the period of the arrangement would be allocated between the reduction of the liability, financing charges and service component. Grant of a right to the operator model Under this model, the grantor compensates the operator for the construction and operation/maintenance of the service concession asset and service provision by granting the operator the right to earn revenue from third-party users of the service concession asset. The grantor in these arrangements is simply transferring their right to earn revenue to the operator for the service concession period. As this would effectively represent the sale of a right, the AASB debated whether the corresponding entry to the recognition of the service concession asset should be a liability (deferred revenue) or revenue recognised immediately at the beginning of the concession period. The AASB decided it was more appropriate for the grantor to recognise a liability for the following reasons: The grantor has an obligation to step-in to provide the public service if the operator fails to perform its obligations under the SCA The grantor controls the asset and only provides a right of access to the asset The grantor is obliged to undertake various activities in relation to the service concession asset over the term of the arrangement AASB 15 requires a performance obligation that grants a right of access to be a performance obligation satisfied over time In reaching this decision, the Board considered the application of existing principles for the recognition of similar transactions. This included the requirements of AASB 15. However, they ultimately concluded that SCAs were sufficiently different in nature from other transactions in which the government provided a license to an entity (e.g., the sale of gaming licenses), and therefore a separate standard was necessary. While there was considerable discussion on the applicability of AASB 15, the Board agreed that such transactions were not in scope of AASB 15. Notwithstanding this, the Board agreed that there are ongoing performance obligations provided by the grantor during the concession period. Therefore, this should result in the grantor being required to defer any revenue to be recognised under the arrangement. Determining fair value Concerns already exist in relation to the application of fair value (as specified by AASB 13 Fair Value (AASB 13)) to public sector assets generally, and similar concerns apply to service concession assets. There are added complications with service concession assets accounted for under the grant of a right to the operator model. For example, consider two SCAs Road A and Road B. For Road A, the grantor is building a road under the financial liability model (i.e., the grantor pays the operator for the construction and operation of the asset). For Road B, the grantor uses the grant of a right to the operator model (i.e., the grantor provides the operator with a right to the cash flows relating to the service concession asset). In applying AASB 13, it could be argued that the economic value of Road B has been reduced because the grantor s ability to generate cash flows from this asset has been significantly diminished. However, from a public service benefit perspective, the fair value of Road A and Road B would be the same. EY Page 3

4 In developing this ED, the AASB considered it more appropriate to address this issue as part of the broader fair value discussion relating to the public sector rather than specifically in this standard. In the interim, it is anticipated that grantors will recognise the service concession assets at fair value, using the depreciated replacement cost method based on the view of service potential, rather than ability to generate cash flows. Comparison with current standards Definition of a public service A key differentiator between this proposal and that of IPSAS 32 and Interpretation 12 is the inclusion of a definition of public service. This was included as it was noted by practitioners that the concept is critical to the application of the ED. Public service is defined as: A service that is provided by government to the community within its jurisdiction, either directly (through the public sector) or by financing the provision of services 3. What is uncertain though is whether assets, like ports, would be captured by this definition as conceptually such assets are actually run for and maintained by the private sector in many circumstances. While port services are provided for the benefit of the community, it is not a service that is provided directly to the community. Government Business Enterprise IPSAS 32, like all other IPSAS, does not apply to Government Business Enterprises (GBEs). However, the AASB has elected to diverge from this practice and not exclude GBEs from the scope of this standard, noting that in numerous cases there are GBEs that control service concession assets as grantors. Therefore, this ED will apply to GBEs. How we see it To date there has not been an Australian Accounting Standard which provides accounting requirements from the grantor perspective for SCAs. While there has been a relatively consistent risks and rewards approach adopted in most jurisdictions, this has been interpreted differently by the various Treasuries: Under the risk and rewards approach, for the grant of a right to the operator model, no service concession assets or associated liabilities are recognised until the end of the concession period. Under the ED, to the extent the control criterion is met, the grantor would be required to recognise the asset and a corresponding deferred revenue liability. For arrangements under the financial liability model, the asset and related liability are likely to be recognised at an earlier point in time. That is, most likely at the beginning of the construction period rather than upon commercial acceptance as is current practice. Next steps The ED is available for comment until 27 July 2015, with an intention to release the final Standard in the first half of EY will be responding to this ED. If you would like any assistance in understanding the potential implications of this ED or in responding to the ED please contact your EY advisor. Transition The proposed standard is intended to be applicable to reporting periods beginning on or after 1 January On transition, grantors are given the option to either: Apply the Standard retrospectively; or Elect to recognise and measure service concession assets and related liabilities at the beginning of the earliest period for which comparative information is presented in the financial statements at deemed cost, being fair value as at that date. The decision to allow the deemed cost election is expected to lighten the reporting burden for users. 3 ED 261: Service Concession Arrangements: Grantor, Appendix A EY Page 4

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