In India, many infrastructure contracts are executed on BOT
(build, operate and transfer) terms under which a company enters into a
contractual agreement with the government or any quasi-government agency to
construct an asset (for example, a road) and to operate it for a specified time
period, before transferring the asset back to the government at the end of the
contracted term.
BOT arrangements are common in areas such as roads, bridges,
airports and power plants. Under such arrangements, there are mainly two types
of contracts : (1) a fixed annuity-based contract under which the operator
company builds the infrastructure asset and gets annuity from the grantor (i.e.,
government body); and (2) a usage based (i.e., toll-based) contract under
which the operator builds the infrastructure asset and collects toll from users.
Under existing Indian GAAP (‘IGAAP’), companies recognise the
infrastructure asset as their own fixed asset, and depreciate it over the
concession period. The amount received from the government and the users of the
infrastructure asset is recognised as income over the period of the concession.
The accounting treatment for such contracts will change under International
Financial Reporting Standards (‘IFRS’). IFRIC 12 (IFRICs are interpretations to
IFRS) on Service Concession Arrangements provides guidance on accounting for
such
arrangements.
Scope of IFRIC 12 :
IFRIC 12 applies to public-to-private service concession
arrangements in which the grantor controls and/or regulates the services
provided and the price, and controls any significant residual interest in the
infrastructure.
Whether or not an arrangement is within the scope of IFRIC 12
will affect the nature of the assets that the operator recognises. For example,
for an arrangement that is within the scope of IFRIC 12, the operator does not
recognise public service infrastructure as its property, plant and equipment (PPE).
Public-to-private service concession arrangements :
While IFRIC 12 does not define public-to-private service
concession arrangements, it does describe the typical features of such
arrangements. Typically a public-to-private service concession arrangement
within the scope of IFRIC 12 will involve most of the following :
(a) Infrastructure is used to deliver public services :
IFRIC 12 states that a feature of public-to-private
arrangements is the public service nature of the obligation undertaken by the
operator.
(b) A contractual arrangement between the grantor and
the operator :
This is the agreement, often termed as concession
agreement, under which the grantor specifies the services that the operator is
to provide and which governs the basis upon which the operator will be
remunerated.
(c) Supply of services by the operator :
These services may include the construction/upgrade of the
infrastructure and the operation and maintenance of that infrastructure.
(d) Payment of the operator over the term of the
arrangement :
In many cases the operator will receive no payment during
the initial construction/upgrade phase. Instead, the operator will be paid by
the grantor directly or will charge users during the period that the
infrastructure is available for use.
(e) Return of the infrastructure to the grantor at the
end of the arrangement :
For example, even if the operator has legal title to the
infrastructure during the term of the arrangement, then legal title may
transfer to the grantor at the end of the arrangement, often for no additional
consideration. In most such arrangements in India, legal title does not pass
on to the operator even during the concession period.
Public-to-private service concession arrangements within the
scope of IFRIC 12 :
The scope of IFRIC 12 is defined by reference to control of
the infrastructure. An arrangement is within the scope of IFRIC 12 if :
(a) the grantor controls what services the operator must
provide with the infrastructure (control of services);
(b) the grantor controls to whom it must provide them
(control of services);
(c) the grantor controls at what price services are charged
(control of pricing); and
(d) 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 (control of the
residual interest).
Control of services :
The grantor may control the services to be provided by the
operator in a number of ways. For example, the services may be specified through
the terms of the concession agreement and/or a licence agreement and/or some
other form of regulation. All of these forms of control are consistent with the
scope criteria of IFRIC 12. Furthermore, the degree of specification of the
services may vary in practice. In some cases the grantor will specify the
services to be provided in detail and by reference to specific tasks to be
undertaken by the operator. In other cases the grantor will specify the services
that the infrastructure should have the capacity to deliver.
Control of pricing :
The grantor may control or regulate the pricing of the
services to be provided using the infrastructure in a variety of ways. The
criterion in IFRIC 12 is generally satisfied when the service concession
involves explicit and substantive control or regulation of prices.
In some cases, particularly when the grantor pays the
operator directly, prices (or a price formula) may be set out in the concession
agreement. In other cases prices may be re-set periodically by the grantor, or
the grantor may give the operator discretion to set unit prices but set a
maximum level of revenue or profits that the operator may retain. All of these
forms of arrangement are consistent with the control criteria in IFRIC 12.
Control of residual interest :
The simplest way in which the grantor may control the residual interest is for the concession agreement to require the operator to return all concession assets to the grantor, or to transfer the infrastructure to a new operator, at the end of the arrangement for no consideration. Such a requirement is a common feature of service concession arrangements involving concession assets with long useful lives, such as road and rail infra-structure. However, other forms of arrangement also are within the scope criteria of IFRIC 12.
‘Whole-of-life’ arrangements, that is, arrangements for which the residual interest in the infrastructure is not significant, are within the scope of IFRIC 12 if the other scope criteria are met.
Accounting for public service infrastructure cost and related revenue:
Accounting for construction/upgrade of infra-structure:
Under IGAAP, the operator recognises the infra-structure as its PPE. However for arrangements within the scope of IFRIC 12 under IFRS, the operator does not recognise public service infrastructure as its PPE, as the operator does not control the public service infrastructure. The control require-ment is determinative irrespective of the extent to which the operator bears the risks and rewards of ownership of the infrastructure.
IFRIC 12 characterises operators as ‘service providers’, who should recognise revenue in accordance with the stage of completion of the services as measured by reference to the fair value of the consideration receivable. This is irrespective of whether the sale consideration is guaranteed by the grantor or is variable based on the usage of infrastructure asset.
Accounting for sale consideration:
The operator recognises consideration received or receivable for providing construction/upgrade services as a financial asset and/or as an intangible asset depending upon the assessment of demand risk.
The operator recognises a financial asset to the extent that it has an unconditional right to receive cash from the grantor irrespective of the usage of the infrastructure.
The operator recognises an intangible asset to the extent that it has a right to charge fees for usage of the infrastructure.
Assessment of demand risk:
The grantor bears the demand risk to the extent it guarantees certain minimum sale consideration irrespective of the usage of the asset. To the extent the grantor bears the demand risk, the operator recognises a financial asset.
Where an arrangement does not guarantee sales consideration and the consideration is linked to the usage of the infrastructure, the demand risk rests with the operator. In such cases, the operator recognises an intangible asset. Even in cases where the arrangement provides a cap on total consideration to be collected from users but does not guarantee minimum sales consideration, the operator shall recognise an intangible asset.
Impact of borrowing costs:
Under IGAAP, borrowing costs incurred during the construction phase are capitalised as part of qualifying fixed assets. Under IFRS, the treatment of borrowing costs differs depending on whether the arrangement qualifies under the financial asset model or the intangible asset model (as discussed above) . In the intangible asset model, the borrowing costs are required to be capitalised to the intangible asset. However, in the financial asset model, the borrowing costs are charged to profits, as financial assets cannot be qualifying assets under borrowing cost standard (i.e., IAS 23).
Recognition and measurement of revenue:
We look at the recognition and measurement of revenue under both the above scenarios — financial asset model and intangible asset model.
Financial asset model:
When the demand risk is with the grantor (i.e., the grantor guarantees the collections that will be recovered over the concession arrangement), the arrangement is said to contain deferred payment terms where the construction revenue is recognised at fair value. It is subsequently measured at amortised cost; i.e., the amount initially recognised plus the cumulative interest on that amount cal-culated using the effective interest method minus repayments. Thus, the overall consideration is broken down into revenue and interest income.
Intangible asset model:
For arrangements where the operator earns revenue purely from collection of tolls that are not guaranteed by the grantor, the right to collect the toll revenue is obtained as a consideration for rendering construction services to the grantor. For accounting purposes, these transactions are treated as barter arrangements. Thus, for such infrastructure projects, companies are required to recognise construction revenue (corresponding amount is debited to the intangible asset i.e., right to collect toll revenue from users) during the course of the construction period; and the toll revenue is recognised separately on collection. The intangible asset is amortised to the income statement over its useful life.
As such, the total amount of revenue recognised over the term of the arrangement is greater than the cash flows received during the period.
Subsequent measurement of financial asset:
The operator accounts for any financial asset it recognizes in accordance with the financial instruments standards (i.e., IAS 39) . There are no exemptions from these standards for operators. As such, the operator is required to classify the financial asset as a loan or receivable, available-for-sale, or at fair value through profit or loss if so designated. Generally, such assets are recorded as loans and receivables.
Subsequent measurement of intangible asset:
IAS 38 allows intangible assets to be measured using either the cost model or the revaluation model. The revaluation model is permitted to be used only if there is an active market for that asset. In most cases there will be no active market for intangible assets recognised under service concession arrangements, and therefore the cost model will be used.
Under the cost model the intangible asset is measured at its cost less any accumulated amortisation and any accumulated impairment losses. The depreciation is based on the asset’s economic useful life, which is generally the concession period.
Financial statement impact for operators on transition to IFRS:
Construction phase of the arrangement:
Under IGAAP, the operator recognises the cost of construction of infrastructure as part of its fixed assets. The fixed assets are depreciated over its useful life (usually over the concession period). Under IFRS, the costs incurred during the construction phase are recognised in income statement as construction
costs (along with the corresponding construction revenue). As the construction cost is recognised upfront in income statement, there would be no impact of depreciation in future years. Thus cost recognised in income statement during initial years is higher under IFRS as compared to IGAAP. Further under IGAAP, no revenue is recognised during the course of the construction phase of the concession arrangement. Under IFRS, revenue is recognised during the course of construction activities (in line with construction cost, based on percentage of completion method). Thus, companies will recognise higher revenues and costs (and higher profits) during the construction period.
Operation revenue:
Under IGAAP, revenue is recognised during the operations phase based on the terms of the concession arrangement. Under IFRS, revenue is recognised depending on whether the concession arrangement falls into financial asset model or intangible asset model. When the operator recognises an intangible asset during the construction phase (i.e., it receives a right to collect fees that are contingent upon the extent of use of the public service), it recognises operation revenue as it is earned i.e., the toll collection is recognised as revenue. Thus there is no impact of IFRS transition on revenue recognition during operations phase. The intangible asset recognised during the construction phase is amortised to income statement over the term of the concession arrangement. Further unlike IGAAP where the fixed asset is capitalised at cost, IFRS requires capitalisation of the intangible asset based on the fair value of construction services. Thus in most cases, the carrying value of intangible asset and related depreciation/amortisation would be higher under IFRS.
When the operator recognises a financial asset during the construction phase (i.e., it receives an unconditional right to receive cash that is not dependent upon the extent of use of the public service), a portion of payments received during the operation phase is allocated to reduce this financial asset (including related imputed interest income. Thus revenue recognition during the operations phase is severely impacted, as a portion of the revenues currently recognized during the operations phase would be adjusted as a recovery of the financial asset.
The table alongside provides a summary impact of the service concession arrangements on transition to IFRS.
Impact of IFRS beyond accounting:
Indian Industry is cautious of the financial statement impact on account of transition to IFRS. However, contrary to the general belief, the impact of transition to IFRS is not restricted to impact on profits and equity.
Financial budget:
On account of transition to IFRS, the financial budgets and performance matrices would undergo a change. Consider, for instance, revenue recognition under financial asset model where the construction revenue is recognised during the course of the construction phase and only interest income/operations revenue recognised during the term of the concession arrangement. This may impact key performance indicators which form a basis on incentive payments to senior employees and also bank covenants (asset cover age ratio, etc.).
Communication with stakeholders:
Management would need to keep stakeholders informed on the change in profitability due to transition related issues.
Contractual impact:
Certain grantors charge companies a certain revenue share every year (which is a percentage of the reported revenues). In case of PPP arrangements accounted under the intangible asset model, total reported revenue is much higher than cash flows earned (as explained above), since the revenue reported during the construction phase is notional. This may lead to higher leakage of regulatory dues which are based on reported revenues.
Similarly, even in the case of a financial asset model, acceleration of revenue recognition (during the construction period) would result in acceleration of contractual cash payments for revenue share (even though the revenues reported have not been realized in cash).
Taxes:
There is a need felt for more clarity on taxation matters vis-à-vis IFRS transition, especially around GST and MAT.
Regulatory:
It remains to be seen whether the statutory financial statements that will now be prepared under IFRS will be accepted for the purposes of filing business plans with banks for borrowing purposes and with RBI/FIPB for investment purposes.
Redefining the systems, processes and data points:
Capturing information under IFRS at a transaction level would pose a significant challenge, atleast in the initial years. The biggest hindrance will be faced on reconfiguration of IT systems, where the investment of time, cost, resources and complexity should not be underestimated. Further, the entity needs to be relook at the process of collecting additional data required under IFRS and make consequential amendment to the internal controls.
While industry believes that the change in the accounting framework is a step in the right direction, they are in the process of estimating the exact impact on their business. The financial and non-financial aspects relating to the IFRS convergence need to be planned and tested in advance of the implementation date. Global experience has shown that the early adopters are generally more successful in managing the overall IFRS transition. The ear-ly-mover advantage not only provides adequate time to carry out required changes, but protects critical decisions being taken within the constraints of time and resources.
succession, survivorship, inheritance, purchase, partition, mortgage, gift, lease, etc., in any land, then he must give a notice of the same to the Talathi within three months of such event.
The Talathi would then enter such changes in a Register of Mutations which would alter the original record of rights.
5.4 Any person buying land especially in a rural or semi-urban area would be well advised to do a thorough title search by checking the Record of Rights, Register of Mutations, etc., which would show whether or not the land in question is an agricultural land, who is the owner, what important developments have taken place in respect of the land, etc.
5.5 In the next Article we shall look at the process for converting an agricultural land into a non-agricultural land.
