“Accounting for public-private partnerships” by Veronica R. Pore (May 2, 2011)

SUITS THE C-SUITE By Veronica R. Pore
Business World (05/02/2011)

In order to carry out the challenge and responsibility of developing and improving public infrastructure, government intends to collaborate with the private sector through the public-private partnership (PPP) program.

A PPP is an arrangement between a public (grantor) and a private (operator) party, wherein the private party assumes substantial financial, technical and operational risks in the financing, construction and operation of a piece of infrastructure for public service.

PPP arrangements are commonly seen in the development of railways, toll roads, water distribution and sanitation, power generation and distribution, port operations, as well as airports and hospitals.

For this year, government has announced the rollout of 10 priority PPP projects which include the development, financing, operation and maintenance of roads, railways and airports.

Funding for these projects involves significant amounts, and usually requires both equity and debt financing.

They also involve various stakeholders, including the government, investors, lenders and the general public.

Proper accounting for these projects, therefore, is critical.


Beginning Jan. 1, 2008, the country adopted the Philippine Interpretation of the International Financial Reporting Interpretations Committee (IFRIC) 12 on Service Concession Arrangements.

It provides specific guidance to operators regarding accounting for public to private service concession arrangements.

Prior to 2008, these arrangements were typically accounted for under Philippine Accounting Standards (PAS) 17 on Leases, and PAS 16 on Property, Plant and Equipment.

In transitioning to IFRIC 12, accounting for assets, liabilities and related revenues and costs could change, depending on the terms and provisions of the arrangement.

As such, it is important to understand how this will affect long-term business plans or forecasts, debt compliance requirements, and key financial ratios required by the various stakeholders of an operator.

When is an arrangement within the scope of IFRIC 12?

An arrangement falls within the scope of IFRIC 12 when the grantor has control over the infrastructure, which is established through:

• control over the service provided by the operator to the infrastructure and control over the price charged to the public:

PPP projects involve construction of infrastructure for a specific public service, which is rendered on behalf of the grantor. Control over the price charged to the public is either explicitly indicated in the contract or through regulation by a government agency such as the Energy Regulatory Commission, Metropolitan Waterworks and Sewerage System, Philippine National Railways or Toll Regulatory Board.

• control over the significant residual interest:

Grantor’s control over the residual interest restricts the operator’s ability to sell or pledge the concession asset or the infrastructure during the period of the arrangement. Control is established if ownership of the infrastructure will be transferred to the grantor at the end of the concession period, or if the entire economic benefit from the infrastructure will be fully used up during the concession period.

How is the service concession arrangement accounted for under IFRIC 12?

Since the grantor has control over the infrastructure, the operator does not recognize the infrastructure as its own property, plant and equipment.

Instead, the operator recognizes either a financial asset or an intangible asset.

In some exceptional circumstances, both a financial asset and an intangible asset are recognized.

A financial asset is recognized when the operator receives guaranteed payments over the period of the arrangement.

The financial asset recognized is accounted for using the guidance from PAS 39, Financial Instruments: Recognition and Measurement, or PFRS 9: Financial Instruments.

Generally, the financial asset model is applicable to arrangements with take-or-pay provisions.

If there are no guaranteed payments and the arrangement allows only a right to charge users for the service, an intangible asset is recognized using the guidance from PAS 38, Intangible Assets.

Construction and operation phases

A typical service concession arrangement is divided into at least two phases: construction phase (development) and operation phase (service).

During the construction phase, the operator accounts for revenues and costs relating to construction services in accordance with PAS 11, Construction Contracts, the accounting treatment of which are the same under both financial asset and intangible asset models.

Since borrowing costs during construction are not treated as part of construction services, they are capitalized under the intangible asset model, but are charged to expenses as incurred under the financial asset model.

There is a difference in the treatment because the financial asset does not meet the definition of a qualifying asset under PAS 23, Borrowing Costs.

During the operation phase, where the arrangement is accounted for under the financial asset model, interest income is recognized via the effective interest rate method.

Under this model, revenues in the earlier years are higher, such that the total income will be front-loaded.

Under the intangible asset model, revenues are recognized when the services are rendered to the public. The intangible asset is amortized over the concession period.

The operator also receives additional service income or operation and maintenance (O&M) fees for the services rendered in operating and maintaining the infrastructure.

These service fees/O&M fees and the related costs are recognized when earned or incurred in accordance with PAS 18, Revenues.

The operator also has an obligation to maintain the infrastructure, at a specified service condition, throughout the concession period.

Costs to repair, maintain and restore the infrastructure are recognized using PAS 37, Provisions, Contingent Liabilities and Contingent Assets.

In restoring the infrastructure to its specified service condition (e.g., every seven years), a yearly provision is recognized at the best estimate of the wear and tear of the infrastructure after considering the time value of money.

Applying IFRIC 12 requires a thorough understanding of the substance and the provisions of the arrangement.

Although salient provisions are generally similar to other concession contracts, there are still cases where minor differences in the terms of the arrangement could have a material effect on its accounting treatment.

Other practical issues relative to the application of IFRIC 12 also include:

• accounting for fixed and variable payments to grantor — Fixed payments may have to be recognized up front on present value basis as an intangible asset with a corresponding liability that may affect sensitive financial ratios of the operator.

• acceptable amortization methods for intangible assets — The straight-line method of amortization may create a mismatch with the revenue stream especially at the early stages of the concession period.

• capitalization of subsequent costs such as upgrades and improvements — Subsequent capital expenditures may have to be charged directly to expense when these are associated with the replacement of existing assets.

To effectively apply IFRIC 12, one must take other relevant accounting standards into consideration, such as those mentioned above.

PPP arrangements are expected to benefit both the country and private investors. Therefore, it behooves prudent operators to fully understand and consider the complexities and practical issues in the application of IFRIC 12, to ensure that their financial objectives and interests are best served.

(Veronica R. Pore is an Audit Partner of SGV & Co.)

This article was originally published in the BusinessWorld newspaper. It is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the author and do not necessarily represent the views of SGV & Co.