Public Private Partnership (PPP) – Accounting Implications

The concept of Public Private Partnership (PPP) was introduced to combine contrasting objectives i.e. public sector whose prime objective is to provide maximum service to general public whereas private sector whose main objective is to maximize profits and returns for its shareholders. There is no consensus on the definition of PPP however, the most relevant definition that I want to share is the one derived by David Weimer and Aidan R. Vinning. According to these two professors:

“a PPP typically involves a private entity financing, constructing, or managing a project in return for a promised stream of payments directly from government or indirectly from users over the projected life of the project or some other specified period of time.”

Considering the governments emphasis on undertaking more and more projects under the PPP framework, it is important for us the accountant to understand how the profits under the projects will flow.

The accounting considerations for the PPP was raised back in 2001 when Standard Interpretation Committee issued SIC 29 – Service Concession Arrangements: Disclosures. However, SIC 29 only provided  guidance on what to disclose in the notes to the financial statements of the operator (private investor) and grantor (public sector entity). In November 2006 IAS issued IFRIC 12 “Service Concession Arrangements” which was effective for annual periods beginning on or after January 1, 2008. IFRIC 12 addresses the accounting issues in the book of the operator. Before we look at how the accounting will flow in the books of the operator, we need to first understand some key definitions provided in the interpretation:

Grantor	A public sector body (including a governmental body, or a private sector entity to which responsibility for a public service has been devolved) that grants the service arrangement.
Operator	A private sector entity that is contractually obliged to provide services to the public on behalf of the public sector entity. The operator is responsible for at least some of the management of the infrastructure and related services and does not merely act as an agent on behalf of the grantor.
Services Arrangement / Service Concession Arrangement	A contract that obliges the operator to provide the services related to the infrastructure to the public on behalf of the grantor. The Contract sets the initial process to be levied by the operator and regulates price revisions over the service arrangement.
Control Criteria	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 The grantor controls any significant residual interest in the infrastructure at the end of the term of the arrangement, through ownership, beneficial entitlement or otherwise.

Important to note here is that the interpretation specifically addresses public to private service concessions and does not apply on services concession arrangements between private parties. Though there may be a situation when the private is partly owned by government but as long as it is acting independently the interpretation applies to it. In addition, the interpretation only applies accounting for operators and not the grantor.

In summary, all of the following criteria are required to be met for an arrangement to fall under IFRIC 12:

1. The arrangement is a public-to-private service concession
2. The grantor controls or regulates the services
3. The grantor controls any significant residual interest
4. The infrastructure is constructed or acquired (or the grantor provides access to that infrastructure) for the purpose of the service concession
5. The operator has either a contractual right to receive cash from or at the direction of the grantor; or a contractual right to charge users of the service.

In general, all build operates transfer and rehabilitate operate transfer arrangements fall under the IFRIC 12.

The following distinguishing accounting principles were introduced by the interpretation:

1. The operator does not recognize infrastructure assets as its property, plant and equipment
2. The operator also provides ‘construction services’ and nor for example, constructs an item of property, plant and equipment for sale. Construction services are to be accounted for separately from ‘operation services; in the operations phase of the contract.
3. The operator either recognizes a financial asset or an intangible asset depending on how the payments are received and who makes the payments.

The interpretation provides two distinct accounting models based on the return flow:

• Financial Asset Model – It applies if the entity has an unconditional contractual right to receive cash or another financial asset.
• Intangible Asset Model – It applies when the financial asset model does not apply

The Financial Asset Model

The model applies when the operator is entitled to received fixed amount of contractual cash. This cash can be paid by the grantor himself or by the user/consumers with a guarantee from the guarantor that any shortfall will be paid by the grantor. The financial asset will be measured on initial recognition at its fair value, and interest will be calculated on the balance using the effective interest method. Revenue will be recognized in accordance with IFRS 15 when the performance obligation in the relation to the construction work is performed.

E.g. 1 Service Concession Agreement – Financial Asset

A private Co. enters into a service concession agreement with government to build operate and transfer a road. The terms of the contracts are as follows:

Description	Amount	Years	Margin / Rate
Construction Cost	Rs. 520 Million	1-2	10%
Operating Cost	Rs. 10 Million	3-10	20%
Effective Interest Rate	–	1-10	5.8%
Fixed Revenue	Rs. 200 Million	3-10	–

The operator does not record the asset as property, plant and equipment instead records a financial asset. The operator will recognize the revenues and costs in its statement of financial performance as follows over the 10 years contract period:

The Intangible Asset Model

The operator recognizes an intangible asset to the extent that it receives a right to charge users of the public service. A right to charge users of the public service is not an unconditional right to receive cash because the amounts are contingent on the extent that the public uses the service. The operator measures the intangible asset at fair value.

E.g. 2 Service Concession Agreement – Intangible Asset

A private Co. enters into a service concession agreement with government to build operate and transfer a road. The terms of the contracts are as follows:

Description	Amount	Years	Margin / Rate
Construction Cost	Rs. 520 Million	1-2	10%
Operating Cost	Rs. 10 Million	3-10	20%
Effective Interest Rate	–	1-10	5.8%
Variable Revenue	Estimated Rs. 200 Million per annum	3-10	–

Similar to financial asset model, the operator does not record the asset as property, plant and equipment instead record an intangible asset. The operator will recognize the revenues and costs in its statement of financial performance as follows over the 10 years contract period:

There may be circumstances where the operator will be required to divide the right cash flows into a financial asset and an intangible asset. To the extent that the operator is remunerated for its construction services by obtaining a contractual right to receive cash from, or at the direction of, the grantor, the operator would recognize a financial asset and, to the extent that the operator receives only a license to charge users, it would recognize an intangible asset.

PPP is important to bring necessary investments from the private sector into the public sector and more effectively manage the public resources. The application of IFRIC 12 significantly change the recognition of revenues and resultantly the net profits of the project. Therefore, it is important that the investor has necessary knowledge of appropriate accounting to calculate the project IRR and plan their project returns especially the dividends that they can take out from the profits of the project.