There is “double accounting” for revenue, first for the construction service and later as the fee or toll charged from users.
The Indian economy has been on a growth drive for the past two decades, with the government stressing on distributed economic growth, using tax and other sops to attract private sector investments. Sustainable economic growth is dependent on the infrastructure available to producers in all sectors of the economy. Till about a decade ago, such infrastructure was mostly provided either free of cost to the public or at a nominal cost, making it an unattractive investment proposition for the private sector. Given the limited public resources available and the need to fast-track infrastructure development, successive Central and State governments entered into partnerships with the private sector to build, own, operate and transfer public infrastructure (popularly called BOOT arrangement).
Currently there is limited guidance in India on accounting for such public-private partnerships, or Service Concession Arrangements (SCA) as they are sometimes called, but the International Financial Reporting Standards (IFRS) contain definitive guidance in the form of an interpretation — the IFRIC 12 ‘Service Concession Arrangements’. Similar guidance is available in Appendix A of Ind-AS 11 (the Indian IFRS-converged standard).
What are Service Concession Arrangements?
In a typical SCA in the Indian scenario, the government or a public sector entity (called ‘grantor’) grants a contract to a private sector entity (called ‘operator’) to construct an infrastructure, along with an exclusive right to operate and maintain it by charging users for a defined period of time, following which the infrastructure goes to the grantor. Under such contracts, the government often controls or regulates the services (nature and price) provided by the operator and any residual interest in the infrastructure at the end of the SCA’s term.
It must be remembered that the operator is only a service provider, not the owner of the infrastructure. Hence, despite constructing it, the operator does not present the infrastructure as property, plant or equipment in its books. Now, is that bad news for the construction sector? Not really — the operator gets to recognise either a financial asset or an intangible asset or both. Let us see how.
The contractor for an airport project is sometimes granted an unconditional right to charge airlines a fixed monthly amount irrespective of the actual footfall at the airport. To the accounting community, this unconditional right is a financial asset (read, loan given by the contractor to the government). In other circumstances, say in the case of a toll road, the payoffs to the contractor are dependent on the use of the infrastructure (more traffic, more return). This right to charge users is not unconditional. Accountants see such a right as an intangible asset. Monetisation of such an intangible asset essentially depends on the user charges and the quantum of usage. In a nutshell, whether the consideration is a financial or an intangible asset is a matter of legal determination — whether the contractor’s rights are unconditional or linked to usage.
What is most interesting in the international accounting guidance are the revenue recognition norms. Let’s say, the operator budgets Rs 100 crore as the cost of constructing an infrastructure and would ordinarily maintain a 10 per cent profit margin in such contracts. The operator recognises the fair value of revenue from construction services — that is, Rs 110 crore, more often using the percentage of completion method. Correspondingly, it recognises an accounting asset (financial or intangible) as the consideration for the construction service. By the time the infrastructure is ready, Rs 10 crore of profit can be recognised without realising a single paise in cash. This may bring some cheer to tax authorities as it results in early recognition of profit and, hence, tax collection.
Now that’s not the end of this mysterious accounting. The receipt of consideration in the form of an intangible asset is even more interesting. It results in “double accounting” for revenue (and, of course, of cost), first as revenue for the construction service (and cost of construction) and later as the fee/ toll charged from users (and amortisation of intangible asset).
The Indian context
While the international accounting guidance is very relevant for the private sector operator in the fair presentation of financial statements and to enhance comparability with international players, some experts argue that these standards would lead to some ambiguity owing to the significant estimates and judgements involved in the fair valuation in recognition of financial or intangible asset, and also leave a wide scope for judgment in revenue measurement. It is worthwhile to note that the CA Institute came up with an exposure draft of a guidance note on the same lines as the international guidance, but it was not made effective.
Until Indian accounting standards align with international practices, diversified accounting practices will prevail, reducing the comparability of financial statements across the construction sector and offering the investor community an opaque view. While some private operators continue to disclose large fixed assets in their financial statements, not reflecting the substance of the arrangement, others have applied the accounting principles contained in ICAI’s draft guidance note. Of course, clarification on tax treatment will nevertheless need to be co-terminus with the alignment of accounting practices.
By Yogesh Sharma, Partner, Assurance, Grant Thornton India LLP. Chartered accountant Siddharth Talwar contributed to the article.
The article was published in The Hindu Business Line on 06 January 2013.