IFRIC 12 Concession Arrangements – summary and examples

The concession agreement is a cooperation between the public and private sectors.

In this agreement, a private sector entity is responsible for the financing, operation, and maintenance of an asset that will provide a service to a community in return for consideration made up of public resources.

In these types of alliances, both the public and private sectors benefit.

For example, if the government of a nation needs to build a road but does not have the necessary budget to carry out such a project, it can agree with the private sector on the development of this project.

In consideration, the entity private may benefit from the collection of tolls.

In this way, the scope of IFRIC 12 only refers to accounting recognition in the private sector company.

Characteristics of the concession agreements

All the requirements shown below must be met for an agreement to be within the scope of IFRIC12.

Before explaining these requirements, it is important to say that this interpretation refers to two parties within a concession contract, the operator and grantor.

The operator is a private sector company in charge of building, improving, and maintaining the infrastructure used to provide a public service.

And on the other hand, the grantor is an entity that represents the public sector responsible for managing the resources delivered to a particular entity.

For example, if the health ministry of a country needs to build 100 hospitals and for this, it makes an agreement with a health-promoting entity, it will be understood that the grantor entity is the health ministry, and the operating entity is the entity in charge of the construction of the asset, which is a private sector entity.

Returning to the requirements established in IFRIC 12, for an agreement to be within the scope of this interpretation, the granting entity must regulate or control the transfer of the services that the operator must provide concerning the use of the asset and what is the price that this entity must charge for the services rendered.

For example, two entities, one from the public sector and the other from the private sector, agree on the construction of transportation service for a community, and within the contract, it is determined that the operator may increase the ticket price when deemed necessary, without taking into account the priorities of the government entity.

And in addition, if the operator could use the asset to eventually mobilize a group of users privates, and the grantor entity cannot control such a situation, this agreement would not be within the scope of IFRIC 12.

The other requirement established in this interpretation is that once the operator has finalized the agreement with the public sector entity, it is obliged to deliver the asset.

Thus, for example, the Ministry of education agrees with a private company for the construction of 50 schools under concession.

Within the agreement, it is determined that the operator will have the management and administration of the assets for 30 years.

Once the agreement ends, the asset will pass into the hands of the state; otherwise, the agreement would not be within the scope of this IFRIC.

Now, this does not mean that the operator cannot receive any consideration at the end of the concession period.

However, this payment must be of a minimum amount, which allows interpreting that the asset must remain in concession for the majority of the useful life of an asset to carry out this operation.

And finally, the last requirement is that if a private sector entity manages a nation’s assets, this operation would not be within the scope of this interpretation.

For example, if the environment ministry carries out the construction of a water treatment plant and gives up the asset management to a private entity, this operation would not be within the scope of this interpretation since the construction of the asset was carried out only with public resources.

In summary, for an agreement to be within the scope of this interpretation, a private company must build an asset or manage it.

And this asset will have the objective of providing a public service.

Besides, the specifications of the services provided and the prices must be regulated by an entity representing the public sector’s interests.

And finally, once the agreement is finalized, the asset will become the state’s property.

The graph shown below is extracted from part B of IFRIC 12.

There the process is specified for an event to be within the scope of this interpretation.

 

IFRIC 12 Service concession

Accounting recognition of concession agreements:

The accounting recognition of this interpretation can only have three accounting options:

  • As a financial asset.
  • As an intangible.
  • As a combination of both

Financial asset model: It may be the case in which a government entity hands over the responsibility to a private party to construct an asset that will have the objective of providing a public service.

The main reason for carrying out this type of operation is that private companies have much more experience constructing a certain type of infrastructure than state entities.

In this way, the private sector entity will manage the asset for a certain period.

And in consideration of this, the entity will receive a disbursement from the grantor entity and not from the people benefiting from the service.

For example, a private sector entity builds a transportation system for a community.

The agreement establishes that the operator will manage the asset for 20 years and also will the collection of the fee for asset use.

But this charge does not correspond to revenue for the private company; it is simply an income for third parties that must be recognized as an account payable to the grantor entity.

The benefit for the operator will be determined by a payment agreement that the grantor will make during the term of the agreement as consideration for the construction of the asset and any maintenance required by the built infrastructure and the operational services that this project entails.

But in no way, in this case, the collection of the fee will represent an income for the private entity, unlike the intangible model that we will see below.

Intangible model: In this model, a public sector entity entrusts a private company with constructing an asset that will provide a public service.

Unlike the financial asset model, in this type of agreement, the grantor entity gives the operator the license to exploit the infrastructure built during a certain period.

For this reason, the private sector company must recognize an intangible asset that will be amortized over the useful life of the agreement.

 Remember that if a contract is constantly renewed and an entity cannot reasonably establish the useful life of the asset, it will be recognized as an intangible asset with an indefinite useful life.

This asset must not be amortized, but it is necessary to review its impairment at the end of the period over which it is informed.

 Now, suppose the entity can establish the useful life of the asset but considers that it may change due to new information that arises.

In that case, the useful life of the intangible must be updated and recognized as a change in an accounting estimate prospectively under IAS. 8.

 Unlike the financial asset model, the operator will only have the right to collect a fee from the users.

This fee must determine in the contract.

On the other side, the cost associated with the infrastructure will be the intangible asset cost.
 
For example, the transport ministry agrees with a private sector entity to build a highway to connect two cities.

 The agreement contemplates the construction, maintenance, operation, and subsequent asset transfer to the nation once the license agreement has expired.

In this way, the operator must recognize an intangible that will be made up of the cost associated with the construction of the infrastructure.

In addition to any financial expense if the entity incurred financing to carry out the project until the asset is in conditions of use.

So, the operator must recognize income from ordinary activities for collecting tolls from users of the asset, based on the regulated price established in the agreement.

Bifurcated model: In this type of model, an entity must recognize a financial asset and an intangible.

For example, a public sector entity agrees with a private entity regarding the delivery under construction of a highway.

The operator has the right to collect the tolls for the community to use the asset during the concession period.

 In addition, if the demand for people who use the asset is less than 50,000 users per month, the grantor will pay the difference in money generated.

 In this way, the operator will recognize an intangible for the project’s costs and must also recognize a financial asset if the passenger demand is lower than that established in the agreement.

Costs included in concession agreements

An entity shall not recognize a property, plant, and equipment for constructing the infrastructure established in the concession agreement.

That is, if a public sector entity entrusts a private entity with the construction of a bridge, this asset is not under the control of the operator entity; for this reason, it should not include this asset in its financial statements.

Besides, when an entity uses the intangible model and obtains external financing from a bank, it may capitalize as a higher value of the intangible the expenses for Interest resulting from the financing of the construction of the asset.

In other words, the infrastructure construction meets the qualifying asset definition under IAS 23.

This is so because its construction period is higher than an accounting period.

 For example, the transport ministry agrees with a private sector company to build a train system to transport a community.

The operator has the right to collect a ticket to use the system.

For the construction of the asset, the entity requests a 10 -year loan with an interest rate of 9%.

The loan costs may be capitalized as a higher value of the intangible until the asset is ready to be used.

Costs excluded in concession agreements

Within a concession agreement, an operator may be obliged to make the maintenance of the asset built during the contract period.

When this type of event occurs, an entity must use the best estimate of the disbursements that it will have to make in the future.

Ie, it must account for a provision under IAS 37.

 The maintenance costs associated with the use of the asset will not be capitalized as a higher value of the intangible.

 However, it is important to say that if the agreement is with the financial asset model, and it is established that an operator may charge for the maintenance performed, this charge will be a higher value of the financial asset.

Financial asset example

A public sector entity establishes a cooperation agreement with a private sector entity for the construction of a hospital that will serve a community.

The construction of the asset will last two years and the operator will have to manage the hospital for 5 years.

The agreement establishes that the operator must carry out maintenance activities in year 4.

The costs associated with the construction of the hospital are shown below:

Construction services year 1: 50,000

Construction services year 2: 60,000

Asset operation services: 3,000 (1,000 per year)

Active maintenance year 4: 9,000

Within the bidding agreement, it is established that the private sector entity will have the right to collect the following items with their profit margins.

 Construction of the Asset : 7%

Management of the asset 9%

Maintenance services; 10%

The amounts to be charged by the operator are the following:

IFRIC12

The effective interest rate established in the agreement is 7.5%.

In this way, the operator will have the right to charge the grantor for the following items:

 The hospital construction.

The operation of the asset.

The maintenance of the asset.

An annual fee is equivalent to 49,552.

 Remember that the operator does not charge hospital users any fee for accessing services in this model.

To finance the project, the operator requests a 5-year loan for 110.00 with an annual rate of 9%.

The financing amortization table is as follows.

 

The financing amortization table

The following flow shows the movement of the financial asset over time

movement of the financial asset

The accounting recognition in year 1 is as follows:

accounting recognition in year 1 FA

The calculation of the implicit interest of the maintenance provision is as follows:

Interest provision-

At the end of year 1, the balance of the financial asset amounted to 57,513, which is equivalent to (53,500 of infrastructure costs of year 1, plus the financing interest charged to the grantor for 4,013 (53,300×7.5%) to reflect the Value.

Accounting recognition in year 2

accounting recognition in year 2 FA

In year 2, the operator must recognize interest income for 4,313.

That is equivalent to the balance of the financial asset of the previous year for 7.5% = (57,513×7.5%)

In addition, the entity must recognize the cost of the project for year two by 60,000.

It is essential to say that the payments to the grantor begin in year 3, which is when the asset comes into operation.

Accounting recognition in year 3.

accounting recognition in year 3 FA

For this year, the operator’s income is 1,090, corresponding to management of the asset and 9,128 of the interest income (121,713×7.5%).

Also, it is necessary to recognize the first payment made by the grantor for 47,893.

 At the end of this year, the balance of the financial asset is: 87,016

IFRIC 12 - 9

Accounting recognition in year 4

accounting recognition in year 4 FA

In year 4, the entity derecognizes the provision for maintenance and recognizes the disbursements necessary to carry out the maintenance of the hospital.

On the other hand, there is a decrease in the financial asset for 32,035 resulting from the difference charged to the grantor for 9,900 for maintenance + income from management of the assets for 1,090 + interest income for 6,526 – collections made in the grantor for 49,552.

Accounting recognition in year 5

accounting recognition in year 5 FA

Intangible asset example

To easily understand this model, we will use the same example as in the financial asset model.

As we saw previously, a private sector entity establishes an agreement with a private entity to construct a hospital.

 Project costs are shown below.

IFRIC 12 - 10

As you can see, unlike the financial asset example, on this occasion, the operator should no longer charge the grantor for maintenance or the operation of the asset since, in this model, the charge is made directly to the user.

In this way, the operator will have the right to charge users an annual fee equivalent to 49,552

To finance the project, the operator requests a 5-year loan for 110.00 with an annual rate of 9%.

The amortization of the loan is as follows:

The financing amortization table

The following flow shows the movement of the intangible asset over time

Movement intangible asset-

As in the financial asset model, the operator must make maintenance of the asset in year 4; these expenditures are not part of the intangible asset and must be recognized as a provision at present value.

Accounting recognition in year 1

accounting recognition in year 1 INT

The intangible must be amortized over three years, which is when the asset will give economic benefits to the operator.

Infrastructure costs year 1: 53,500

Financial costs: 9,900

Infrastructure costs year 2: 64,200

Financial costs: 8,246

Total intangible: 135,846

Under IAS 23, the entity capitalizes on the interests associated with the asset construction.

Accounting recognition in year 2

accounting recognition in year 2 INT

Until year 2, the interests resulting from the project’s financing will be capitalized.

Subsequently, they will be recognized as expenses for the period.

Accounting recognition in year 3

accounting recognition in year 3 INT

The annual fee charged to users is recognized as income from ordinary activities under IFRS 15.

Accounting recognition in year 4

accounting recognition in year 4 INT

Accounting recognition in year 5

accounting recognition in year 5 INT
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