New Accounting Rules for
Service Concessions
New Accounting Rules for Service Concessions
Table of Contents
INTRODUCTION ..................................................................................................................................................... 3
BACKGROUND ....................................................................................................................................................... 3
ACCOUNTING TREATMENT .................................................................................................................................... 3
CURRENT ......................................................................................................................................................................3
ASU 2014-05 ..............................................................................................................................................................4
Scope .....................................................................................................................................................................4
Effective Date & Transition ...................................................................................................................................5
NEW BALANCE SHEET CLASSIFICATION .................................................................................................................. 6
FINANCIAL ASSET ...........................................................................................................................................................6
INTANGIBLE ASSET..........................................................................................................................................................9
OTHER ISSUES ...................................................................................................................................................... 12
REVENUE RECOGNITION ................................................................................................................................................12
IMPACT ON CONSOLIDATION CONSIDERATIONS ..................................................................................................................12
DEPRECIATION OF PP&E VERSUS AMORTIZATION OF INTANGIBLE ASSETS ...............................................................................12
BORROWING COSTS ......................................................................................................................................................13
POST-IMPLEMENTATION REVIEW OF IFRIC 12...................................................................................................................13
CONCLUSION ....................................................................................................................................................... 13
CONTRIBUTOR ..................................................................................................................................................... 14
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New Accounting Rules for Service Concessions
Introduction
Recently, the Financial Accounting Standards Board (FASB) released a new accounting standard that may affect the
accounting treatment for service concession arrangements. This paper reviews the scope and terms of the new
standard with examples of the alternative accounting treatment that may be required. Entities that currently
engage in service concession arrangements should carefully review the terms of existing agreements to assess the
impact on financial statements. The standard is effective for 2015; if an accounting change is required, entities
should begin collecting historical data, considering changes to data processing systems and reviewing potential tax
implications.
Background
A service concession arrangement (SCA) generally refers to a negotiated contract that gives a private entity the
right to do business with government assets, with some specific requirements. Such arrangements also are known
as public-private partnerships (PPP). These arrangements enable the public sector to benefit from private sector
expertise and efficiencies; usually the PPP is structured so the public sector entity does not incur any borrowing to
deliver new or refurbished public sector assets. Examples of PPPs include water treatment and supply facilities,
motorways, car parks, tunnels, bridges, airports and telecommunication networks. The asset may already exist or
the operating entity may construct the asset during the SCA term. Typically, the operator is required to return the
asset at the end of the agreement.
While Europe has had a long and mostly successful history of using PPPs, the U.S. story is one of fits and starts.
The first U.S. private toll road dates back to 1792 with the opening of the Philadelphia and Lancaster Turnpike.
Almost 10,000 miles of private roads were built in the early 1800s. Unfortunately, the competition of railroads and
steamboats caused less-profitable routes to be closed or turned over to governments. The first major modern SCA
was completed in 2005 when the city of Chicago leased its seven-mile tollway for an upfront payment of $1.83
billion. Even as governments continue to struggle to maintain aging infrastructure, SCAs have not become as
prevalent as initially expected. At least 11 private toll projects since 1995 have struggled financially, primarily due
to traffic not meeting projections.
The outlook for PPPs may be changing. In June 2013, Congress agreed to expand a loan program to finance tollroad construction. Funding for the Transportation Infrastructure Finance and Innovation Act (TIFIA) program was
increased to $1 billion a year from $122 million. The program leverages federal money with local spending and
offers below-market rate loans with 35-year terms and deferred payments. Existing laws in 33 states allow such
partnerships to be formed for transportation projects.
PPPs have evolved to include social infrastructure projects such as schools, prisons and courthouses. For example,
in 2011, Long Beach, California completed a $495 million courthouse through a PPP arrangement where the
developer is paid via several mechanisms such as rent and parking revenue. In addition, many new structures
require minimum guaranteed payments from the public sector entity to reduce risk to bond holders. The
expansion of highways in Orlando and Fort Lauderdale incorporate set payments instead of the right to keep toll
revenue. The respective public sector grantors would receive the toll revenue and have to augment it with money
from its operating budget if traffic fails to generate enough funding to cover costs.
Accounting Treatment
Current
Local and state government grantors in PPP arrangements rely on Governmental Accounting Standards Board
Statement No. 60, Accounting and Financial Reporting for Service Concession Arrangements, for the appropriate
accounting treatment. However, for private sector PPP partners, U.S. generally accepted accounting principles
(GAAP) previously lacked accounting guidance for service concession contracts.
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New Accounting Rules for Service Concessions
Under existing guidance, an operator would first consider if the service concession arrangement is a lease under
Topic 840, Leases. If so, the lease would be classified as either capital or operating. The current lease analysis
required in assessing these arrangements is complex and can be driven by microlevel interpretations of fixed-priceper-unit concepts in the leasing literature. This means two arrangements that are very similar in economic
substance can be accounted for differently based on the current lease analysis. As a result, some entities account
for the transaction as a lease and apply the guidance in Topic 840, while others account for the rights in the
contract as an intangible asset, a financial asset or both.
ASU 2014-05
As a result of the diversity in practice, in January 2014, FASB issued Accounting Standards Update (ASU) 2014-05,
Service Concession Arrangements (Topic 853). Reporting entities subject to a service concession arrangement with
a public sector grantor who controls or has the ability to modify or approve the services should not account for the
agreements as a lease nor recognize the infrastructure used in a service concession arrangement as property, plant
and equipment. Instead, the reporting entity should refer to other U.S. GAAP guidance to account for various
aspects of a service concession arrangement.
Scope
FASB concluded the accounting for service concession arrangements should be determined on the basis of
whether the operating entity controls the infrastructure that is being used to provide the public service. Under the
new standard, operating entities enter into a service concession arrangement with a grantor entity when both of
the following conditions exist:

The grantor controls or has the ability to modify or approve what services the operating entity must
provide with the infrastructure, to whom it must provide them and at what price

The grantor controls, through ownership, beneficial entitlement, or otherwise any residual interest in the
infrastructure at the end of the term of the arrangement
The scope of the proposal excludes arrangements in which control of the infrastructure is not retained by the
grantor. The scope is limited to public sector grantors and would exclude any nongovernmental organizations
such as not-for-profits that may be grantors in these types of arrangements.
The grantor may control or regulate the pricing of services to be provided in a variety of ways. Prices (or a
formula) may be set out in the contract. In other cases prices may be reset periodically by the grantor, or the
grantor may give the operator discretion to set unit prices but set a maximum level of revenue or profits that the
operator may retain. Prices may be indexed by, or reset periodically by, the grantor. Although the grantor can’t
control the value of the index, it is controlling the framework in which the price is set. All of these arrangements
would be within scope of the new standard.
When both criteria are met, the operating entity should not recognize the agreement as a lease under Topic 840.
The emphasis on “control” distinguishes ASU 2014-05 from the previous “risk and reward” approach under the
current lease standard. The control requirement is determinative irrespective of the extent to which the operator
bears the risks and rewards of ownership of the infrastructure. The substance of the arrangement may convey the
responsibilities customary of ownership over the infrastructure to the operating entity during the term of the
arrangement; however, because the operator does not control the infrastructure, it cannot recognize property,
plant and equipment on its balance sheet.
Regulated Operations
Regulated operations and service concession arrangements are similar in that the price that can be charged for the
service is determined by the grantor. However, the scope of Topic 980, Regulated Operations, differs from the
scope of this update because, in regulated operations, the infrastructure is typically controlled by the operating
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New Accounting Rules for Service Concessions
entity and the residual interest is retained by the operating entity, unlike service concession arrangements. If an
operating entity is within the scope of Topic 980, an entity should continue to follow that guidance.
Why Not a Lease?
Current Lease Standard
In many SCAs, the operating entity is receiving substantially all of the economic output from the infrastructure
during the term of the arrangement, but the price paid is not fixed per unit of output or at current market price
per unit of output. As such, SCAs generally meet one or more of the following conditions to qualify as a lease:

Operates the asset in a manner it determines while obtaining or controlling more than a minor amount of
the asset’s output

Can control access to the assets while obtaining or controlling more than a minor amount of the asset’s
output

It is remote that one or more parties other than the operator will take more than a minor amount of the
output, and the price the operator will pay for the output is neither contractually fixed per unit of output
nor equal to the current market price per unit of output as of the time of delivery
Under either the second or third criterion of current GAAP, control over the use of an asset does not require the
entity to have the ability to direct use of the asset.
Lease Exposure Draft
In May 2013, FASB released an exposure draft (ED) substantially changing lease accounting. The ED defines a lease
as a contract that conveys the right to use an asset for a period of time in exchange for consideration. When
evaluating whether a contract includes a lease, entities would need to determine the following:

If fulfillment of the contract depends on the use of an identified asset

Whether the contract conveys to the lessee the right to control use of the asset for a period of time in
exchange for consideration
A contract would convey the right to control the use of an identified asset when the customer has the ability to do
both of the following:

Direct the use of the asset throughout the contract term

Derive substantially all of the potential economic benefits from use of the asset throughout the
contractual term
An entity would have the ability to direct the use of an identified asset when the contract gives that entity the right
to make decisions about the use of the asset that most significantly affect the economic benefits to be derived
from its use throughout the contract term.
SCAs would fail the ED’s right to control test because the operating entity does not direct how, when and in what
manner the infrastructure will be used. While the operating entity may have wide managerial discretion in
operating the infrastructure, it does not control the infrastructure because the grantor determines the services the
operating entity must provide, to whom it must provide them and at what price. In addition, the grantor controls
any residual interest in the infrastructure at the end of the arrangement term.
The lease proposal‘s control concept differs from existing lease accounting standards because it requires both
the right to obtain benefits from the asset and the entity’s ability to direct use of the asset.
Effective Date & Transition
For an entity other than a public business entity, the effective date is for annual periods beginning after December
15, 2014, and interim periods within annual periods beginning after December 15, 2015. The update is effective
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New Accounting Rules for Service Concessions
for public business entities for annual periods, and interim periods within those annual periods, beginning after
December 15, 2014.
Entities should use the modified retrospective basis for service concession arrangements that exist as of the
beginning of the fiscal year of adoption, which would result in an adjustment to the opening retained earnings
balance that year. Early adoption is permitted.
New Balance Sheet Classification
Entities that previously had treated all or part of an SCA as a capital lease will need to change the balance sheet
classification. The ASU did not include specific guidance on what asset should be recognized; an entity must
evaluate the arrangement terms in order to determine the balance sheet asset to be recognized under existing
accounting guidance. Common PPP payment arrangements include the following:

Revenue/demand based – the private sector entity controls and collects project revenues, which serve as
the only source of compensation

Availability payments based – the grantor provides a predetermined schedule of payments to repay debt
and provide a return on equity; the operator is compensated only to the extent that performance
standards are met and the asset is available for use as per the concession agreement

Shadow fee – a hybrid model that allows the grantor to set rates and revenue policy and still expose the
operator to demand risk for the infrastructure; the operator is paid a fixed fee per user of the facility,
accepting demand but not revenue-collection risk

Mixed – the private sector receives revenues from users with additional revenue from the grantor
An operating entity may recognize an intangible asset representing the right to charge users of the public service it
constructs or operates, or an operator may recognize a financial asset if it has an unconditional contractual right to
receive cash from, or at the discretion of the grantor in return for constructing or upgrading, a public sector asset.
Lease
Financial Asset unconditional right
to recieve cash
Intangible Asset right to charge users
Financial Asset
U.S. GAAP defines a financial instrument as cash, evidence of an ownership interest in a company or other entity,
or a contract that does both of the following:

Imposes on one entity a contractual obligation to do one of the following:
•
•
Deliver cash or another financial instrument to a second entity
Exchange other financial instruments on potentially unfavorable terms with the second entity
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New Accounting Rules for Service Concessions

Conveys to that second entity a contractual right to do one of the following:
•
•
Receive cash or another financial instrument from the first entity
Exchange other financial instruments on potentially favorable terms with the first entity
An operator may recognize a financial asset if it has an unconditional contractual right to receive cash from, or at
the discretion of the grantor in return for constructing or upgrading, a public sector asset. The financial asset could
be classified as a loan or a receivable and could subsequently be measured at amortized cost or fair value, e.g., an
agreement whereby the operator has a guarantee by the grantor of minimum revenue that will not fall below a
specified level.
Determination of the fair value of a financial asset recognized in a service concession arrangement may be
difficult, and substantial judgment may be required, because it is unlikely to be an active market for a right to
receive guarantees payments under a service concession arrangement.
If some payments receivable under the service concession arrangement are not expected to be recovered
following payment defaults by the grantor, the financial asset would be considered impaired and an impairment
loss would be recognized and measured.
The ASU does not specify how the operator should account for a financial asset recognized on transition. Further
complexities may arise when an operator should account for both a financial asset and an intangible asset on
transition. The ASU is silent on how the carrying amounts of previously recognized asset should be allocated
between the assets currently recognized. Judgment will be required in performing this allocation.
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New Accounting Rules for Service Concessions
Example – Financial Assets Model
An operator enters into a contract to construct and operate a bridge for 10 years for a flat fee of $200 million
from the state government grantor. The fair value of the construction services provided is $110 million. Assume
the inputted financing revenue is $10 million. The balance of $80 million is attributed to the operational services.
The following journal entries would be made:
CONSTRUCTION PHASE
Dr. Financial asset
110
Cr. Construction revenue
110
To recognize revenue related to construction services to be settled in cash
Dr. Cost of construction
100
Cr. Cash
100
To recognize costs related to construction services
OPERATIONAL PHASE
Dr. Financial Asset
10
Cr. Finance Revenue
10
To recognize interest income
Dr. Financial Asset
80
Cr. Revenue
80
To recognize revenues related to the operational phase
Dr. Cash
200
Cr. Financial Asset
200
To recognize cash received from the grantor
Total revenue over the life of the contract
200
Total cash inflows over the life of the contract 200
Contracts usually establish a flat fee without splitting out the construction service consideration, which will
reduce the financial asset, and the operating services, which will be revenue. It will be necessary to identify the
underlying revenue stream that relates to both activities. The allocation will require a significant amount of
management judgment.
In practice, some companies first establish an appropriate discount rate in order to determine the appropriate
profit margins on the construction and operating services. Significant judgment is required in the selection of the
appropriate discount rate and the allocation of total consideration received or receivable for the relative fair
value of the construction and operational services delivered, as this will affect the future revenue recognition
pattern.
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New Accounting Rules for Service Concessions
Intangible Asset
Accounting Standard Codification (ASC) 350, Intangibles – Goodwill and Other defines an intangible asset as a
nonmonetary asset that lacks physical substance. FASB’s definition specifically excludes monetary assets in their
definition of an intangible asset. The intangible asset model applies if the operator receives a right (a license) to
charge users, or the grantor bases payment on usage of the public service. There is no unconditional right to
receive cash, as the amounts are contingent on the extent the public uses the service. An intangible asset that is
acquired generally is recognized and measured based on its fair value.
The accounting for a recognized intangible asset is based on its useful life to the reporting entity. An intangible
asset with a finite useful life is amortized; an intangible asset with an indefinite useful life is not amortized. The
useful life of an intangible asset is the period over which the asset is expected to contribute directly or indirectly to
that entity’s future cash flows. The method of amortization should reflect the pattern in which the economic
benefits of the intangible asset are consumed or otherwise used up. If that pattern cannot be reliably determined,
a straight-line amortization method should be used. An impairment loss should be recognized if the carrying
amount of an intangible asset is not recoverable and its carrying amount exceeds its fair value. After an
impairment loss is recognized, the adjusted carrying amount of the intangible asset will be its new accounting
basis. Subsequent reversal of a previously recognized impairment loss is prohibited.
Concessions are generally granted for long periods of time. Therefore, there often are changes in the initial
estimates of future cash flows related to arrangements for a variety of reasons, including the following:
 Changes in the usage of the infrastructure by the users, e.g., increase in traffic on the road
 Changes in estimated costs or other assumptions relating to the arrangement
Such changes might be an indicator of impairment of the intangible asset or suggest the need to review the
amortization method for the intangible.
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New Accounting Rules for Service Concessions
Example – Intangible Asset
An operator enters into a contract to construct and operate a bridge for 10 years. The operator has the right to
all tolls collected for the term of the arrangement, estimated to be $200 million. This amount is not guaranteed
by the grantor. The fair value of the construction services provided is $110 million. The following journal entries
would be made:
CONSTRUCTION PHASE
Dr. Intangible asset
110
Cr. Revenue
110
To recognize revenue related to construction services to be settled in noncash consideration
Dr. Cost of construction
100
Cr. Cash
100
To recognize costs related to construction services
OPERATIONAL PHASE
Dr. Amortization expense
110
Cr. Intangible Asset (Accumulated depreciation)
110
To recognize amortization expense related to the operational phase
Dr. Cash
200
Cr. Revenue
200
To recognize revenues related to the operational phase
Total revenue over the life of the contract
310
Total cash inflows over the life of the contract 200
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New Accounting Rules for Service Concessions
Example – Hybrid Model
An operator enters into a contract to construct and operate a bridge for 10 years. The operator has the right to all
tolls collected for the term of the arrangement, estimated to be $200 million, of which $60 million is guaranteed by
the grantor. The fair value of the construction services provided in $110 million. The following journal entries
would be made:
CONSTRUCTION PHASE
Dr. Financial asset
60
Cr. Revenue
60
To recognize revenue related to construction services to be settled in cash
Dr. Cost of construction
100
Cr. Cash
100
To recognize costs related to construction services
Dr. Intangible Asset
50
Cr. Revenue
50
To recognize revenue related to construction services provided for noncash consideration
OPERATIONAL PHASE
Dr. Financial Asset
6
Cr. Finance Revenue
6
To recognize finance revenues
Dr. Amortization expense
50
Cr. Intangible Asset (Accumulated depreciation)
50
To recognize amortization expense related to the operational phase
Dr. Cash
200
Cr. Revenue
134
Cr. Financial Asset
66
To recognize revenues related to the operational phase and cash received from the grantor and users
Total revenue over the life of the contract
250
Total cash inflows over the life of the contract 200
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New Accounting Rules for Service Concessions
Other Issues
Revenue Recognition
An operating entity would account for revenue and cost related to construction, upgrades or operating services in
according with Topic 605 on revenue recognition. Operators would recognize revenue related to construction
irrespective of whether the consideration received is classified as a financial asset or an intangible asset.
Impact on Consolidation Considerations
Under U.S. GAAP, different principles apply in determining whether an entity has control of an asset versus control
of another entity. If an infrastructure used in the service concession arrangement is held within an entity and
controlled by that entity, the reporting entity should first determine whether it should consolidate the
infrastructure under Topic 810 before applying the guidance in ASU 2014-05. If consolidation is not required, an
operating entity should assess whether the arrangement qualifies for the scope of this ASU. If the arrangement is
within the scope of the update, the reporting entity should not recognize the arrangement as a lease or the
infrastructure as property, plant and equipment.
Depreciation of PP&E Versus Amortization of Intangible Assets
Once a lease is set up as a capital lease, the asset is depreciated over the asset's economic life if there is an
ownership transfer or bargain purchase option; otherwise, it is depreciated over the term of the lease.
Amortization is the process of expensing out intangible assets over their useful life. It is, in effect, the depreciation
of intangible assets. Most intangible assets are amortized using the straight-line method. Useful life is the shorter
of legal life and economic life. While the straight-line method may be appropriate for many service concession
arrangements, different methods also may be acceptable.
Some toll road operators use a “traffic-based depreciation method” for bridges and roads, whereby depreciation
is a function of both time and usage. The impact of usage on depreciation is taken into account with traffic
volume. The time factor implies an asset has a maximum longevity, regardless of usage. Depreciation expense
cannot be less than the straight-line amount, which would be calculated using the asset’s maximum economic
life, which is longer than its estimated useful life. Depreciation expense for an individual asset is the greater of
the amount computed under the traffic-based depreciation method or straight-line method over the individual
asset’s maximum economic life.
This table illustrates the initial allocation of the Chicago Skyway’s concession payment and direct costs of $1.8
billion. Under the new standard, the property, plant and equipment will need to be derecognized and another
financial or intangible asset recognized that may not be subject to depreciation or have a different economic life.
Estimated useful life
Fair value allocation at
inception of winning bid
and other direct
acquisition costs ($000s)
Concession right
Life of lease (99 years)
1,513
Bridge and road
50 years
323
Building
50 years
1
Leasehold interest in land
Life of lease (99 years)
9
Skyway equipment
7 years
2
Skyway asset
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New Accounting Rules for Service Concessions
Borrowing Costs
The historical cost of acquiring an asset includes the costs necessarily incurred to bring it to the condition and
location necessary for its intended use. If an asset requires time to carry out the activities necessary to bring it to
that condition and location, the interest cost incurred during that period as a result of expenditures for the asset is
a part of the historical cost of acquiring the asset.
ASC 835, Interest, requires capitalization of interest costs while a qualifying asset is being prepared for its intended
use. Qualifying assets—those for which interest should be capitalized—generally are:

Assets constructed for an entity's own use

Deposits or progress payments on assets constructed by others

Assets intended for sale or lease that are constructed as discrete projects, e.g., ships or real estate
developments

Equity method investments (equity, loans and advances) while the investee has qualifying activities or
expenditures in progress

Those that require a period of time to get them ready for their intended use
Borrowing costs attributable to a concession arrangement would be capitalized during the construction phase, if
the operator has a contractual right to receive an intangible asset. Since a financial asset is not a qualifying asset,
borrowing costs would be recognized as an expense in the period incurred.
Post-Implementation Review of IFRIC 12
In 2006, the International Accounting Standards Board (IASB) addressed accounting treatment for these
arrangements in IFRS Interpretations Committee (IFRIC) 12, Service Concession Arrangements. IFRIC 12 mandates
which International Financial Reporting Standard (IFRS) should be applied for various aspects of service concession
arrangements. Unlike IFRIC 12, FASB’s ASU does not provide specific accounting guidance for service concession
arrangements but, rather, indicates the operator should refer to other topics as applicable to account for various
aspects of a service concession arrangement. IFRIC 12 was effective for fiscal years beginning January 1, 2008, and
in 2010 the European Commission prepared a post-implementation review. The two standards are similar, and the
feedback may be insightful for U.S. entities as they consider transition implications.
Preparers adopting the IASB’s standard previously had recognized infrastructure under SCAs primarily as property,
plants and equipment. In fewer cases, infrastructure was recognized as an intangible asset. Amortization of these
tangible assets was usually made on a straight-line basis. In some cases, amortization was done on a "usage basis"
approach. The study concluded that, for most entities, implementation and application costs were not significant.
Entities that had to reclassify some tangible assets as either intangible or financial assets noted the total value of
these assets did not change significantly. There was some impact on income statements, but some changes were
offset. For example, amortization of assets decreased as a result of the reclassification of some tangible assets as
financial assets and revenues on financial assets increased.
Financial statement users felt the application of IFRIC 12 helped them better assess an SCA’s nature, performance
and related risk exposures. Financial analysts said the new presentation provided clearer focus on cash flows and
remuneration, improving their analysis of risk exposure, which they felt could reduce financing costs.
Conclusion
There are many different types of service concession arrangements, as well as multiple different accounting
methods previously applied by preparers in accounting for those arrangements. Entities should carefully analyze
each arrangement to determine the appropriate accounting based on the individual facts and circumstances.
Contact your BKD advisor with any questions or for more information.
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New Accounting Rules for Service Concessions
Contributor
Anne Coughlan
Director
317.383.4000
[email protected]
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