Accounting for Service Concession agreements (PPPs)

Accounting for Service Concession agreements (PPPs) Seminar on Accounting reforms in the Public Sector: IPSAS/EPSAS Brussels, May 13, 2016 Thomas Müller-Marqués Berger, EY Germany

Agenda Overview of service concession arrangements (SCAs) or publicprivate partnerships (PPPs) IPSAS 32: Accounting for SCAs/PPPs Page 2

Overview of SCAs/PPPs Page 3

What do we mean by Infrastructure? Social infrastructure Transport Defence Oil & Gas Power & Utilities Mining & Metals Real Estate / Construction Telecoms Two key types of Infrastructure investment New build infrastructure ( Greenfield ) Built infrastructure ( Brownfield ) (c. US$60 trillion over next 10 years) (c.us$300bn refinancing in 2014 alone) Page 4

What are the key trends driving global infrastructure investment and activity? Rapid growth in emerging markets Resilient cities Clean energy and renewables Major events Capital Agenda Changing technology, patterns and smart infrastructure Globalization of supply chains Digital agenda Decommissioning of Infrastructure Page 5

Growing market: GDP growth in emerging markets and growth economies are driving future investment Over $6 trillion in global capital investment per annum between 2015 and 2025 c.us$6 - US$8tr Americas c.us$10 US$13tr Europe, Middle East, Africa Projected Global Infrastructure spending (2010-2030): US$40 - US$50trillion Source: Oxford Economics c.us$24tr US$29tr Asia Pacific $60bn p.a. Addressable Market with a Whole-of-firm approach (c.1% of spend) Page 6

What s driving governments to use PPPs? Key Trends Growth. Population growth and urbanisation continue to spur demand for infrastructure and services Funding Gap. Inability of governments to finance current and future infrastructure assets Budgetary pressure. Achievement of community expectations whilst avoiding debt or adverse budgetary impacts Maintenance. Governments must upgrade, replace, and build out essential infrastructure assets for the community Investment. Diversifying financial portfolios with investors seeking asset classes for long-term investments yielding steady, positive returns Innovation. Innovation and technology have allowed private sector to bring expertise and new practices to the public sector Page 7

Accounting for SCAs/PPPs Page 8

Possible funding and financing options From operations/general reserves From special rates/charges From developer contributions, sale of assets, asset transfers Federal/state government grants Borrowings from treasuries, private institutions Public to private partnership arrangements - long term private sector debt financing Page 9

Financial reporting of service concession arrangements international perspective Public Sector ( Grantor ) Private sector ( Operator ) Statistics Accounting SNA 2008/GFSM 2011/PSDSG 2013 IPSAS 32 IFRIC 12 Risk and Rewards- Approach Control- Approach Control- Approach IPSAS 32 mirrors IFRIC 12 Page 10

Accounting approaches for PPPs Risks and rewards vs control Accounting Ownership Accounting in Practice Relevant Standards Risk and Rewards Approach Accounting ownership of an asset lies with the party that: carries the risks, benefits and burden in connection with the asset. Typically construction risk and asset availability risk are transferred to the private sector entity; while service demand risk is not => In that case PPP scheme is booked as service arrangement, i.e. no service concession asset, no liability IFRIC 4/IAS 17 IPSAS 13 GFSM 2010 ESA 95/2010 E.g. IPSAS 32 requires: Control Approach Accounting ownership of an asset lies with the party that: controls what services the private sector partner must provide, to whom and what price and has control over the residual value of the asset Recognition of service concession asset based upon power to control and regulate the use of the asset Recognition of obligations as either a financial liability or as deferred income IFRIC 12 IPSAS 32 Page 11

Key Risks Phases in PPP that can determine Accounting Treatment Where most of the project risk has been transferred to the non-government partner, the assets involved in the PPP are deemed to be off the public sector balance sheet. Construction risk Potential risks related to: delays in delivery, execution of the contract without meeting specified standards, significant additional cost, technical deficiency etc. Who is the owner of construction risks of the project? Type of Risks Considered: Demand Risk Projects where an element of user demand funds the underlying assets or services. Is the party taking demand risk on the project to fund assets or services? Availability risk Projects where payment is based on the delivery of assets and services. Who is the party responsible for delivery of assets and services? BUT the key premise of PPP is to transfer risk to the party best able to manage that risk. Accounting treatment MUST NOT drive Risk Allocation Page 12

On and Off Balance Sheet Treatment Off-Balance sheet On-Balance sheet Implies accounting only for the annual payments it makes to the PPP operator, and not for the assets and liabilities of the project, including its debt It is attractive as long-term obligations under PPPs do not appear under government s financial statements/budget and help to keep government net debt within the reference value However credit rating agencies are now challenging this view in government ratings On-balance sheet treatment implies the recording of total liabilities when the project commences or at commercial acceptance Typically reported through liability (deferred revenue) with the investment in PPP assets recorded from the outset and amortized over the project life Implies that it consequently increases gross liabilities recognised on balance sheet. Net-effect is balanced by recognition of an asset Page 13

Accounting Requirements of IPSAS 32 Page 14

Accounting requirements of IPSAS 32 Overview Under IPSAS 32, SCAs would result in infrastructure assets being regarded as controlled by government Scope IPSAS 32 applies to all public sector entities other than Government Business Enterprises Arrangements within the scope of IPSAS 32 must involve the operator providing public services related to the service concession asset on behalf of the grantor Examples of arrangement that are outside the scope of IPSAS 32 are those that do not involve the delivery of public services; where arrangements that involve service and management components where the asset is not controlled by the grantor; include outsourcing, service contracts or privatization: Page 15

Accounting requirements of IPSAS 32 Overview Definitions Service Concession Arrangement is a binding arrangement between a grantor and an operator in which the operator uses the service concession asset to provide a public service on behalf of the grantor for a specified period of time; and the operator is compensated for its services over the period of the service concession arrangement. A grantor is the entity that grants the right to use the service concession asset to the operator An operator is the entity that uses the asset to provide public services subject to the grantor s control of the asset A service concession asset is an asset used to provide public services in a service concession arrangement that is provided by the operator (construct/develop/acquire or existing asset) is provided by the grantor (existing asset or update) Page 16

Accounting requirements of IPSAS 32 Overview - What is a service concession asset? An asset used to provide public services in a service concession arrangement that is Provided by the operator which Provided by the grantor which Constructs, develops or acquires from a third party Or Is an existing asset of the operator Is an existing asset of the grantor Or Is an upgrade to an existing asset of the grantor Page 17

Accounting requirements of IPSAS 32 Accounting for service concession asset Recognition A government recognizes an asset in its financial statements when (IPSAS 32.9): The grantor controls or regulates the services to be provided by the operator and The grantor controls any significant residual interest in the asset at the end of the arrangement However: the recognition criteria in IPSAS 17/ IPSAS 31 have to be fulfilled it is probable that future economic benefits associated with the item will flow to the entity the cost or fail value of the item can be measured reliably -> e.g. during construction period: progress reports by the operator (AG23). Page 18

Accounting requirements of IPSAS 32 Accounting for service concession asset Measurement Initial measurement of the asset is at fair value does not constitute revaluation under IPSAS 17 Property, Plant and Equipment / IPSAS 31 Intangible Assets (IPSAS 32.11) After initial recognition, the asset shall be accounted for as a separate class of assets in accordance with IPSAS 17 or IPSAS 31, as appropriate historical cost method revaluation method In cases where an existing asset is subject to a SCA, the grantor shall reclassify the asset the requirement of IPSAS 32.11 does not apply to reclassifications, i.e. no re-measurement at fair value in this case (AG24)! Page 19

Accounting requirements of IPSAS 32 Accounting for liabilities Recognition key principle: Where the grantor recognizes an asset in accordance with IPSAS 32.9, he should also recognize a liability (IPSAS 32.14). but: do not recognize liability when an existing asset is reclassified! Nature of the liability depending on the nature of the consideration exchanged between grantor and operator payments to the operator financial liability model compensating the operator by other means: granting the right to earn revenue from users; or granting access to another revenue-generating asset grant of a right to the operator model Page 20

Accounting requirements of IPSAS 32 Accounting for liabilities If government compensates the operator for construction by making a predetermined series of payments during the life of the PPP (a government-funded PPP): Government recognizes the assets and a financial liability equal to the full value of the assets If government compensates operator for construction by granting the operator the right to earn revenues from users (a user-funded PPP): Government recognizes the assets and deferred revenue equal the full value of the asset Page 21

Accounting requirements of IPSAS 32 Accounting for liabilities Measurement: The liability recognized shall be initially measured at the same amount as the service concession asset (IPSAS 32.15) It is likely that the government s gross debt increases by the amount of the liability, while net worth remains unchanged Subsequent measurement is depending on the nature of the liability Financial liability model: measurement according to IPSAS 29 (IPSAS 32.20) Grant of a right model: the grantor shall account for the liability as the unearned portion of the revenue arising from the exchange of assets with the operator (IPSAS 32.24). For mixed arrangements: it is necessary to account separately for each part of the total liability recognized (IPSAS 32.27). Page 22

Accounting requirements of IPSAS 32 Accounting for liabilities financial liability model Analysing the payment stream The grantor shall allocate the payments to the operator and account for them according to their substance (IPSAS 32.21) Total payment stream Amortization = reduction of the liability (IPSAS 32.21) Finance Charge = expense (IPSAS 32.22) Service Charge = expense (IPSAS 32.22) Page 23

Accounting requirements of IPSAS 32 Accounting for liabilities financial liability model How to allocate the payment streams (IPSAS 32.23): Asset and service components are separately identifiable: service components shall be allocated by reference to the relative fair values of the asset and the services Asset and service components are not separately identifiable: the service component of payments to the operator is determined using estimation techniques (similar transactions observable?) i.e. the fair value of the asset (IPSAS 32.11) is determined by using estimation techniques (AG31) assessment of comparable assets Service component is recognized evenly over the term of the arrangement best correspondents to service provision only in cases when specific expenses are required to be separately compensated, and timing is known, these are recognized as incurred (AG46) Page 24

Accounting requirements of IPSAS 32 Accounting for liabilities Grant of a Right Model SCA is an exchange transaction IPSAS 9 applies Background information from the Basis for Conclusions: Grantor controls asset allows operator to generate revenue Rights Asset exchanged assets are dissimilar Operator builts asset operates and charges users revenue recognition according to IPSAS 9: exchange is regarded as transaction that generates revenue if and as it results in an increase in the net assets of the grantor (BC35). in general: economic substance of an SCA provides an increase in net assets, so revenue accrues and should be recognized (BC29). Key question: to which period(s) has the revenue to be allocated? timing is over period of arrangement. Until the criteria for revenue recognition have been satisfied, credit is recognized as liability (BC39). Page 25

Accounting requirements of IPSAS 32 Accounting for liabilities grant of a right model General principle (IPSAS 32.24): the grantor shall account for the liability recognized in accordance with para.14 as the unearned portion of the revenue arising from the exchange of assets As the right granted to the operator is effective for the period of the arrangement, the grantor does not recognize revenue from the exchange immediately (IPSAS 32.26; under ED 43: performance obligation ) the grantor earns the benefit associated with the assets received in exchange for the right granted to the operator over the period of the arrangement (AG47) The revenue is recognized according to the economic substance of the service concession arrangement, and the liability is reduced as revenue is recognized Page 26

EY Contacts ey.com Thomas Müller-Marqués Berger German Certified Public Accountant Partner Global Leader International Public Sector Accounting Phone: +49 711 9881 15844 Mobile: +49 160 939 15844 Fax: +49 181 3943 15844 thomas.mueller-marques.berger @de.ey.com Ernst & Young GmbH Wirtschaftsprüfungsgesellschaft Mittlerer Pfad 15 70499 Stuttgart Thomas, Global Leader of EY s IPSAS Sector Group, was the German Board Member of the IPSASB (2009-2014), since 2016 he is the Chairman of the IPSASB CAG. Besides that, Thomas is Chairman of the Public Sector Committee (PSC) of the Federation of European Accountants (Fédération des Experts Comptables Européens - FEE). Thomas has many years of worldwide experience in auditing and advising governments as well as public and municipal companies, and European organisa-tions including Eurostat. In 2009-2010 he was also appointed as external IPSAS expert for the temporary DAS Think Tank of the European Court of Auditors. Since 2013, Thomas is a member of the Accounting Advisory Group of the European Commission. As FEE PSG chair, he contributed to both Eurostat Task Forces EPSAS Governance and EPSAS Standards. Currently, he represents FEE at the EPSAS Working Group and Cells. Page 27