Illustrative examples (AASB1059_07-17_COMPdec21_01-22)

These examples consider only three of many possible types of service concession arrangements. Their purpose is to illustrate the accounting treatment for some features that are commonly found in practice. To make the illustrations as clear as possible: ,

(a) It is assumed in Examples 6–7 that the term of the service concession arrangement is only ten years and that the operator’s annual receipts are constant over that period. In practice, terms may be much longer and annual revenues may increase over time;

(b) Examples 6 and 7 do not illustrate the accounting by the grantor for existing assets of the grantor used in the service concession arrangement, such as land under roads; and

(c) Example 8 presents only relevant terms of the arrangement that illustrate the requirements for dividing the liability under a hybrid service concession arrangement into the financial liability and the grant of the right to the operator liability.

In these examples, monetary amounts are denominated in ‘currency units’ (CU) – rounded to the nearest unit.

These terms are common to the two examples that follow.

The terms of the arrangement require an operator to construct a road on land owned by the grantor – completing construction within two years – and maintain and operate the road to a specified standard for eight years (ie years 3–10). The arrangement is within the scope of this Standard and the road meets the conditions for recognition of a service concession asset in paragraph 5.

The terms of the arrangement also require the operator to resurface the road when the original surface has deteriorated below a specified condition. The operator estimates that it will have to undertake the resurfacing at the end of year 8 at a fair value (current replacement cost) of CU110. The compensation to the operator for this service is included in the predetermined series of payments and/or the revenue the operator has the right to earn from the service concession asset or another revenue-generating asset granted to the operator by the grantor. The compensation to the operator also covers the annual operating costs of CU12.

It is assumed that the original road surface is a separate component of the service concession asset and meets the criteria for recognition specified in AASB 116 when the service concession asset is initially recognised. The road surface is therefore recognised as a separate component of the initial fair value (current replacement cost) of the service concession asset and depreciated over years 3–8. This depreciation period is shorter than that for the road base, and takes into account that resurfacing would ordinarily occur every six years, compared with replacing the road base in 25 years. During the construction phase, it is assumed that only the road base is constructed in year 1, and that the road only becomes ready to use at the end of year 2.

The replacement of a major component of the road as a separate component of the service concession asset occurs in year 8, and is recognised as a new service concession asset when the resurfacing work is performed. This also results in an increase in the liability recognised by the grantor, in accordance with paragraph B48. Where the liability relates to the grant of a right to the operator model, additional revenue in respect of this increase is recognised evenly over the remaining term of the arrangement. However, if the expenditure represented an improvement in service potential such as a new traffic lane rather than restoration to original service capability then it would be appropriate to instead recognise revenue relevant to that improvement only once it has occurred.

At the beginning of year 3, the total fair value (current replacement cost) of the road is CU1,082, comprised of CU972 related to the base layers (including implied funding costs due to the extended construction period) and CU110 related to the surface layers. The fair value of the surface layers is used to estimate the fair value of the resurfacing (which is treated as a replacement component in accordance with AASB 116). The estimated life of surface layers (ie six years) is also used to estimate the depreciation of the replacement component in years 9 and 10.

The road base has an economic life of 25 years. Annual depreciation is recognised by the grantor on a straight-line basis. It is therefore CU39 (CU972/25) for the base layers. The surface layers are depreciated over 6 years (years 3–8 for the original component, and starting in year 9 for the replacement component). Annual depreciation related to the original surface layers and the replacement surface layers is CU18 (CU110/6).

The effective interest rate in the service concession arrangement is 6.18 per cent per year.

It is assumed that all cash flows take place at the end of the year.

It is assumed that the time value of money is not significant.

At the end of year 10, the arrangement will end and the operator will transfer the operation of the road to the grantor.

The total compensation to the operator under each of the two examples is inclusive of each of the components of the service concession arrangement and reflects the fair values (current replacement cost) for each of the assets and services, which are set out in Table 6.

The grantor’s accounting policies include:

(a) service concession assets (property, plant, and equipment) – measured initially at fair value (current replacement cost) and subsequently in accordance with the cost model. Impairment is recognised when the carrying amount exceeds the current replacement cost;

(b) financial liabilities – subsequently measured at amortised cost using the effective interest method; and

(c) borrowing costs – expensed in the period incurred regardless of how the borrowings are applied.

Table 6 Fair values of the components of the arrangement (currency units)

The terms of the arrangement require the grantor to pay the operator CU200 per year in years 3–10 for making the road available to the public. The total consideration (payment of CU200 in each of years 3–10) reflects the fair values (current replacement cost) for each of the assets and services indicated in Table 6. These payments are intended to cover the cost of constructing the road, annual operating costs of CU12 and reimbursement to the operator for the cost of resurfacing the road in year 8 of CU110.

The grantor initially recognises the service concession asset as property, plant, and equipment at its fair value, measured at current replacement cost (total CU1,082, determined as CU940 related to construction of the base layers, CU110 related to construction of the original surface layers and CU32 for funding costs related to the costs incurred in year 1 for base layers). The asset is recognised as it is constructed (CU525 in year 1 and CU557 in year 2). Depreciation is recognised annually (CU57, comprised of CU39 (CU972/25) for the base layers and CU18 (CU110/6) for the surface layers), starting from year 3.

The grantor initially recognises a financial liability equal to the fair value (current replacement cost) of the service concession asset under construction at the end of year 1 (CU525). The liability is increased at the end of year 2 to reflect both the fair value of the additional construction (CU525) and the finance charge (CU32) on the outstanding financial liability. Because the amount of the predetermined payment related to the service component of the service concession arrangement is known, the grantor is able to determine the amount of the annual payment that reduces the liability each period. A finance charge at the effective interest rate of 6.18 per cent is recognised annually. The liability is subsequently measured at amortised cost, that is, the amount initially recognised plus the finance charge on that amount calculated using the effective interest method, minus repayments. The initial liability excludes the annual operating costs of CU12 and the compensation for the road resurfacing, as these components of the arrangement represent equally proportionately unperformed contracts.

The compensation for the road resurfacing is included in the predetermined series of payments. There is no additional direct cash flow impact related to the road resurfacing beyond the predetermined payments; however, the grantor recognises the resurfacing as an asset when the work is undertaken and recognises depreciation expense of CU110/6 = CU18, beginning in year 9. When the resurfacing occurs, the grantor also recognises the related liability.

The compensation for maintenance and operating the road (CU12) is also included in the predetermined series of payments. There is no additional cash flow impact related to this service expense beyond those payments; however, the grantor recognises an expense annually.

The grantor’s cash flows, statement of profit and loss and other comprehensive income, and statement of financial position over the duration of the arrangement will be as illustrated in Tables 6.1 to 6.3. In addition, Table 6.4 shows the changes in the financial liability.

Table 6.1 Cash flows (currency units)

Table 6.2 Statement of profit and loss and other comprehensive income (currency units)

Table 6.3 Statement of financial position (currency units)

Table 6.4 Changes in the financial liability (currency units)

The terms of the arrangement allow the operator to collect tolls from drivers using the road. The operator forecasts that vehicle numbers will remain constant over the duration of the arrangement and that it will receive tolls of CU200 in each of years 3–10. The total consideration (tolls of CU200 in each of years 3–10) reflects the fair values (current replacement cost) for each of the assets and services indicated in Table 6, and is intended to cover the cost of constructing the road, annual operating costs of CU12 and reimbursement to the operator for the cost of resurfacing the road in year 8 of CU110.

The grantor initially recognises the service concession asset as property, plant, and equipment at its fair value (current replacement cost) (total CU1,082, determined as CU940 related to construction of the base layers, CU110 related to construction of the original surface layers and CU32 for implied funding costs related to the costs incurred in year 1 for base layers). The asset is recognised as it is constructed (CU525 in year 1 and CU557 in year 2). Depreciation is recognised annually (CU57, comprised of CU39 (CU972/25) for the base layers and CU18 (CU110/6) for the surface layers), starting from year 3.

As consideration for the service concession asset, the grantor recognises a liability under the grant of a right to the operator model for granting the operator the right to collect tolls of CU200 in years 3–10. The liability is recognised as the asset is recognised. The liability is measured initially at the same amount as the asset, which includes an implied funding cost in the measurement of the current replacement cost.

The liability is reduced over years 3–10, and the grantor recognises revenue on that basis because access to the service concession asset is expected to be provided evenly over the term of the service concession arrangement from the point at which the asset is capable of providing economic benefits.

The compensation for the road resurfacing is included in the tolls the operator expects to earn over the term of the service concession arrangement. There is no additional cash flow impact related to the road resurfacing; however, the grantor recognises the resurfacing (the replacement of a major component of the road) as a service concession asset when the work is undertaken and recognises depreciation expense of CU110/6 = CU18, beginning in year 9. When the resurfacing occurs, the grantor also recognises the related liability.

The compensation for maintenance and operating the road (CU12) is also included in the tolls the operator expects to earn over the term of the service concession arrangement. There is no financial statement impact related to this service expense. It does not affect cash flow because the grantor has no cash inflow or outflow. It is not recognised as an operating expense because the fair value (current replacement cost) of the asset and liability initially recognised do not include any service costs the operator may incur.

The grantor’s cash flows, statement of profit and loss and other comprehensive income, and statement of financial position over the duration of the arrangement will be as illustrated in Tables 7.1 to 7.2. In addition, Table 7.3 shows the changes in the liability.

Because no payments are made by the grantor to the operator, there are no cash flow impacts for this example.

Table 7.1 Statement of profit and loss and other comprehensive income (currency units)

Table 7.2 Statement of financial position (currency units)

Table 7.3 Changes in the liability (currency units)

Example 8 illustrates the requirements in paragraphs 24–25 and B73–B74 for dividing a hybrid service concession arrangement by measuring the financial liability part first and then allocating the remainder of the total liability to the part related to the grant of the right to the operator.

The relevant terms of the arrangement in the example are:

(a) the operator is required to construct a road on land owned by the grantor – completing construction within two years – and maintain and operate the road to a specified standard for eighteen years (ie years 3–20);

(b) the grantor is required to pay the operator CU100 each year for eight years (ie years 3–10) for making the road available to the public. These payments are intended to partially cover the cost of constructing the road. It is assumed all cash flows take place at the end of the year. The contractually specified interest rate in the arrangement is 4% per annum. The present value of the payments is CU673. However, unlike a typical loan, the grantor incurs the liability two years before cash payments commence from year 3. Consequently, the effective interest rate for the financial liability is 3.2% per annum, reflecting this timing difference. The grantor’s accounting policy for the financial liability is to subsequently measure the financial liability at amortised cost using the effective interest method;

(c) the operator is permitted to collect tolls from drivers using the road for eighteen years (ie years 3–20);

(d) the initial fair value (current replacement cost) of the construction cost of the service concession asset is CU1,800, once construction is complete at the end of the second year; and

(e) at the end of year 20, the arrangement will end, and the operator will transfer the operation of the road to the grantor.

The arrangement is within the scope of this Standard and the road meets the conditions for recognition as a service concession asset in paragraph 5 (or paragraph 6 for a whole-of-life asset).

It is necessary to divide the grantor’s consideration to the operator into two parts – the financial liability for the predetermined payments and the liability related to the grant of the right to the operator to charge tolls.

The grantor recognises:

(a) the service concession asset as property, plant and equipment at current replacement cost in accordance with the cost approach to fair value (current replacement cost) in AASB 13 totalling CU1,822 at the end of year 2, related to construction of the road (CU900 in both year 1 and year 2) and funding costs related to the financial liability recognised in year 1 (CU22 in year 2);

(b) the total liability equal to the same amount as the current replacement cost of the service concession asset (total CU1,822). The total liability is allocated:

(i) in year 1 – first to the financial liability measured at present value under AASB 9. In this example, the present value of the grantor’s payments to the operator is CU673. Second, the remainder of the CU900 is allocated to the liability under the grant of the right to the operator model for the right to collect tolls (CU227);

(ii) in year 2 – to the liability under the grant of the right to the operator model for the right to collect tolls (CU900) as the remainder of the liability related to the construction costs; and

(iii) in year 2 – the borrowing costs of CU22 are allocated to the financial liability;

(c) a finance charge expense (CU22) in year 2 relating to the financial liability in year 1, in accordance with the grantor’s accounting policy; and

(d) a revaluation surplus of CU22 to reflect the inclusion of funding costs relating to the construction period in the current replacement cost of the service concession asset.

The journal entries for the accounting treatment set out in paragraph IE34 are:

Example 9 illustrates the requirements in paragraphs B14 and B39(a) for the initial recognition of the assets of a business that is subject to a service concession arrangement, including identifiable intangible assets.

The relevant terms of the arrangement in the example are:

(a) a grantor enters into an arrangement that involves an operator providing public services related to a business, on behalf of the grantor. The business is a business as defined in AASB 3 Business Combinations, with customer lists and property, plant and equipment. The customer lists are intangible assets as they would meet the separability criterion in AASB 3. They were developed and are owned by the grantor;

(b) the initial fair value (current replacement cost) of the business and the identifiable assets of the business are set out in Table 9;

(c) the operator has the right to collect revenue in relation to updating the customer lists; and

(d) at the commencement of the arrangement, the operator provides the grantor with cash consideration of CU300.

Table 9 Fair values of the components of the arrangement (currency units)

The arrangement is within the scope of this Standard and, as existing assets of the grantor, the property, plant and equipment and customer lists meet the conditions for a service concession asset in paragraph 5 (or paragraph 6 for a whole-of-life asset).

The grantor has not previously recognised the customer lists as an intangible asset as they are precluded from recognition as an intangible asset under AASB 138. As a result of entering into the service concession arrangement, the grantor recognises the assets of the business, excluding any internally generated goodwill, as service concession assets. Therefore the grantor initially:

(a) reclassifies the property, plant and equipment as a service concession asset and recognises the asset at fair value (current replacement cost) (CU100), representing a revaluation surplus of CU40 over the carrying amount of CU60;

(b) reclassifies the customer lists as an intangible service concession asset and recognises the asset at fair value (current replacement cost) (CU150) and a corresponding amount as revaluation surplus; and

(c) recognises a liability under the grant of a right to the operator model for the additional consideration (CU300) provided by the operator.

The journal entries for the accounting treatment set out in paragraph IE39 are:

In accordance with the transition requirements set out in Appendix C of the Standard, a grantor may elect to apply the Standard retrospectively by recognising and measuring service concession assets and related liabilities at the date of initial application (paragraph C3(b)). The date of initial application is the beginning of the earliest reporting period for which comparative information is presented in the financial statements.

This example illustrates the approach set out in paragraph C4(c) to measuring a liability under the grant of a right to the operator model at the date of initial application. The liability related to the grant of a right to the operator is required to be measured at the fair value (current replacement cost) of the related service concession asset at the date of initial application, adjusted (1) for any consideration transferred by the grantor to the operator that is recognised as an asset and (2) to reflect the remaining period of the service concession arrangement relative to the total period of the arrangement, (3) less any related financial liabilities.

Assuming that the service concession arrangement in this example has not required any payments or other consideration from the grantor to the operator and does not give rise to a financial liability for the grantor, the information needed for measuring the liability is illustrated in the following table:

Table 10 Estimates at the date of initial application

If the service concession arrangement is a hybrid arrangement, the carrying amount of any consideration transferred by the grantor to the operator that has been recognised as an asset is first deducted from the fair value (current replacement cost) of the service concession asset. The resulting amount is then apportioned for the remaining service concession period. Any outstanding financial liability (measured separately under the financial liability model at fair value at the date of initial application) would then be deducted from the apportioned amount for the liability re the grant of rights to the operator in order to derive the amount to be recognised for the liability.

The measurement approach illustrated in this example is a simplified transition method, as it does not require the service concession asset or the liability to be measured at the inception of the service concession arrangement, as would be required under the full retrospective transition method in accordance with AASB 108 Accounting Policies, Changes in Accounting Estimates and Errors.