International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards
Page 360
at the end of the year 8. At the end of year 10, the service arrangement will end. The operator estimates that
the costs it will incur to fulfil its obligations will be:
Table 1 Contract costs
Year
€
Construction services (per year)
1-2
500
Operation services (per year)
3-10
10
Road resurfacing
8
100
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 contract and that it will receive
tolls of €200 in each of years 3-10.
For the purpose of this illustration, it is assumed that all cash flows take place at the end of the year.
Intangible asset
The operator provides construction services to the grantor in exchange for an intangible asset, i.e. a right to
collect tolls from road users in years 3-10. In accordance with IFRS 15, the operator measures this non-cash
consideration at fair value. In this case the operator determines the fair value indirectly by reference to the
stand-alone selling price of the construction services delivered.
During the construction phase of the arrangement the operator’s contract asset (representing its accumulating
right to be paid for providing construction services) is presented as an intangible asset (licence to charge users
of the infrastructure). The operator estimates the stand-alone selling price of the construction services to be
equal to the forecast construction costs plus 5 per cent margin, which the operator concludes is consistent
with the rate a market participant would require as compensation for providing the construction services and
1828 Chapter 26
for assuming the risk associated with the construction costs. The operator also capitalises borrowing costs
during the construction phase as required by IAS 23, at an estimated rate of 6.7 per cent:
Table 2 Initial measurement of intangible asset
€
Construction services in year 1 (€500 × (1 + 5%))
525
Capitalisation of borrowing costs
34
Construction services in year 2 (€500 × (1 + 5%))
525
Intangible asset at end of year 2
1,084
The intangible asset is amortised over the period in which it is expected to be available for use by the operator,
i.e. years 3-10. In this case, the directors determine that it is appropriate to amortise using a straight-line
method. The annual amortisation charge is therefore €1,084 divided by 8 years, i.e. €135 per year.
Construction costs and revenue
The operator accounts for the construction services in accordance with IFRS 15. It measures revenue at the
fair value of the non-cash consideration received or receivable. Thus in each of years 1 and 2 it recognises in
its income statement construction costs of €500, construction revenue of €525 (cost plus 5 per cent) and,
hence, construction profit of €25.
Toll revenue
The road users pay for the public services at the same time as they receive them, i.e. when they use the road.
The operator therefore recognises toll revenue when it collects the tolls.
The accounting for the operations phase of this example service concession arrangement is discussed in
Example 26.12 at 5.2 below.
4.3.1
Amortisation of the intangible asset
The intangible asset will subsequently be accounted for in accordance with IAS 38,
[IFRIC 12.26], and the amount at which it is measured initially, i.e. after the exchange
transaction, is its cost. [IAS 38.45]. It will be amortised on a systematic basis over its useful
life, using a method that reflects ‘the pattern in which the asset’s future economic
benefits are expected to be consumed by the entity’. [IAS 38.97]. This means that the
methods permitted by IAS 38 are available (straight line, diminishing balance or unit-of-
production). [IAS 38.98]. The requirements of IAS 38 are discussed in detail in Chapter 17.
Interest methods of amortisation are forbidden. [IFRIC 12.BC65].
The Interpretations Committee expressly considered unit-of-production methods to be
appropriate in some circumstances; in March 2006, it was noted in the IFRIC Update
that the Basis of Conclusions had been redrafted to avoid the impression that these
methods were not allowed.8 There were still concerns that a unit-of-production method
could result in lower amortisation in the early years of the asset’s operation so IAS 38
itself was amended to remove a statement discouraging methods that might have such
a result.9 This clarifies that there is no prohibition when the method is the most
appropriate, whatever the resulting profile of amortisation.
Unit-of-production methods are typically considered in the context of toll roads and
bridges. Obviously the method might apply if there is a right to charge a specified
number of users. Questions still remained as to whether it might also be used if the basis
was the estimated number of users, e.g. the number of vehicles that might use a
particular road during the concession term.
Service concession arrangements 1829
The remaining issue regarding amortisation methods has been whether they could be based
on revenue generated by the asset; this depends on the meaning of ‘consumption of
economic benefits’ in the context of intangible assets with finite lives. In May 2014, the IASB
issued amendments to IAS 38 to introduce a rebuttable presumption that a method of
amortisation based on the revenue expected to be generated from an activity that includes
the use of an intangible asset is not appropriate. This is because this method typically reflects
factors that are not directly linked to the consumption of the economic benefits embodied
in the asset. [IAS 38.98A]. See Chapter 17 at 9.2.1. Similar amendments have been made to
IAS 16 except that there is no rebuttable presumption regarding depreciation based on
revenue, [IAS 16.62A], see Chapter 18 at 5.6. The amendment became effective in 2016.
Example 26.5 below demonstrates the potentially distorting effects for a SCA of basing
amortisation on revenue.
However, the Board did acknowledge certain ‘limited circumstances’ that would give
rise to an exception to this presumption. Revenue generated can be used to amortise an
intangible asset when: [IAS 38.98A]
• the rights embodied in that intangible asset are expressed as a measure of revenue; or
• when it can be demonstrated that revenue and the consumption of economic
benefits are ‘highly correlated’.
The Board did not define what is meant by ‘highly correlated’, but it describes situations
where the asset is ‘expressed as a measure of revenue’. A ‘highly correlated’ outcome
would only be achieved where a revenue-based method of amortisation is expected to
give the same answer as one of the other methods permitted by IAS 38. For example, if
revenue is earned evenly over the expected life of the asset, the pattern of amortisation
would be similar to a straight-line basis. In situations where unit prices are fixed and all
production is sold, the pattern of amortisation would replicate the use of the units-of-
prod
uction method. However, when unit prices are not fixed, revenue would not
provide the same answer and its use would therefore be inappropriate. The following
example illustrates how a revenue-based method of amortisation diverges from the
units-of-production method when the price per unit is not fixed.
Example 26.5: Output-based versus revenue-based amortisation when prices
change
Entity Z enters into a twenty-five year SCA over a toll bridge. It recognises an intangible asset of £20 million and
expects the bridge to be used at its full capacity of 500,000 vehicles per year. Tolls will commence at £10 per vehicle
and, under the terms of the SCA, it is allowed to raise prices by 10% every five years. On this basis, the profile of
amortisation on a units-of-production method (UoP) and on a revenue-based method would be as follows:
Charge
Charge
Units
UoP basis
Revenue
Revenue basis
£
£
£
Years 1-5
500,000
4,000,000
5,000,000
3,276,000
Years 6-10
500,000
4,000,000
5,500,000
3,604,000
Years 11-15
500,000
4,000,000
6,050,000
3,964,000
Years 16-20
500,000
4,000,000
6,655,000
4,360,000
Years 21-25
500,000
4,000,000
7,320,500
4,796,000
Total
2,500,000
20,000,000 30,525,500
20,000,000
1830 Chapter 26
Despite an expected constant level of consumption of the asset in the example above,
the revenue-based method results in amortisation being delayed until the later periods
of the asset’s use. This distortion is caused by the increase in price rather than any factor
related to the use of the intangible asset.
The Board permits revenue-based amortisation to be used when revenue is ‘the
predominant limiting factor that is inherent in the intangible asset’. [IAS 38.98B]. In other
words, revenue determines the useful life of the asset, rather than, for example, a
number of years or the number of units produced.
The IASB provided two examples of this circumstance in which revenue earned can be
regarded as a measure of consumption of an intangible asset: [IAS 38.98C]
(a) a contract may allow the extraction of gold from a mine until total cumulative
revenue from the sale of gold reaches $2 billion; or
(b) the right to operate a toll road could be based on a fixed total amount of revenue
generated, based on cumulative tolls that have been charged.
An example of (b) is a SCA arrangement, described at 4.1.2 above, in which an operator
enters into a toll bridge concession under which it is permitted to collect revenues from
users or the grantor until it achieves a 6% return on its agreed infrastructure spend, at
which point the arrangement comes to an end. As explained at 4.1.2, this will be
accounted for as an intangible asset because the operator bears demand risk and may
never achieve the revenue target. In this case the operator could calculate amortisation
based on cumulative revenue as a percentage of total revenue.
The choice of amortisation method is a matter of judgement. In the following extract
from its accounting policies, ENGIE indicates that it amortises its intangible assets on a
straight line basis over the concession term to reflect the pattern of consumption.
Extract 26.2: ENGIE SA (2017)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS [extract]
NOTE 1 ACCOUNTING STANDARDS AND METHODS [extract]
1.4 Accounting
methods [extract]
1.4.4 Intangible
assets [extract]
1.4.4.2
Other intangible assets [extract]
Other internally-generated or acquired intangible assets
Other intangible assets include mainly:
• amounts paid or payable as consideration for rights relating to concession contracts or public service contracts;
• customer portfolios acquired on business combinations;
• capacity rights, in particular regarding power stations; the Group helped finance the construction of certain nuclear power stations operated by third parties and in consideration received the right to purchase a share of the production over the life of the assets. Said capacity rights are amortized over the useful life of the related assets, not exceeding 50 years;
• concession assets;
• fulfilment contract costs.
Intangible assets are amortized on the basis of the expected pattern of consumption of the estimated future economic
benefits embodied in the asset. Amortization is calculated mainly on a straight-line basis over the following useful lives:
Service concession arrangements 1831
Useful life
Main depreciation periods (years)
Minimum Maximum
Concession rights
10
30
Customer portfolio
10
40
Other intangible assets
1
50
Some intangible assets with an indefinite useful life are not amortized but an impairment test has to be performed annually.
4.3.2
Impairment during the construction phase
As noted at 4.3 above IFRS 15 requires the operator to recognise a contract asset during
the construction phase. [IFRIC 12.19]. IFRS 15 requires contract assets to be assessed for
impairment in accordance with IFRS 9. [IFRS 15.107]. The impairment requirements of
IFRS 9 are discussed in Chapter 47 at 5.
4.4
Revenue recognition implications of the two models
There are major differences in the way in which revenue is measured under the two
models. Under the financial asset model, total revenue over the concession term will be
the same as the total cash inflows under the contract. By contrast, the fair value of the
intangible asset is recognised as revenue under the intangible asset model, so total
revenue measured using this model will be higher by this amount. The consequences of
the two models can be demonstrated by the following simple example:
Example 26.6: Revenue under the financial asset and intangible models
An operator builds a road at a cost of 100. The construction profit is 10 and total cash inflows over the life of
the concession are 200. Assume that there is no significant financing component in the arrangement.
Under the financial asset model, the operator will recognise construction revenue of 110 and a receivable of
110. Of the future cash inflows of 200, 110 will be treated as repaying the receivable, with the remaining 90
being recognised as revenue over the life of the concession. Total revenue will be 200.
Under the intangible asset model, the operator will recognise construction revenue of 110, an intangible of
110, and a construction profit of 10. Over the life of the concession, the intangible asset of 110 would be
amortised against revenues (which in this case would be from users) of 200. The net position is the same as
in the financial asset case, but total revenues will be 310 rather than 200.
It is fair to say that this proved highly
controversial. In fact, the September 2004
IFRIC Update stated that ‘the majority of the Interpretations Committee strongly
disliked this outcome’.10 However, the Interpretations Committee maintained that
this is the appropriate application of accounting standards to the arrangements and
is consistent with the treatment generally accorded to barter transactions,
[IFRIC 12.BC35], although, of course, there are no other sectors where barter
transactions are fundamental to the arrangement. The interaction of the IFRIC 12
intangible asset model with IFRS 15 is discussed at 5.4 below. The possible
implications for many other transactions with governmental grantors where licences
are granted have not been considered.
1832 Chapter 26
4.5
‘Bifurcation’ – single arrangements that contain both financial
and intangible assets
The Interpretations Committee concluded that it may be necessary in certain
circumstances to divide the operator’s right to cash flows into a financial asset and an
intangible asset. [IFRIC 12.18]. The IFRIC Update (March 2006) reported that ‘With this
change, the proposed amendment would better reflect the economic reality of concession
arrangements: to the extent that the operator is remunerated for its construction services
by obtaining a contractual right to receive cash from, or at the direction of, the grantor,
the operator would recognise a financial asset and, to the extent that the operator receives
only a licence to charge users, it would recognise an intangible asset.’
The Basis for Conclusions to IFRIC 12 explains more of the reasoning and potential
impact. In some arrangements both parties to the contract share the risk (demand risk)
that the cash flows generated by the project will not be sufficient to recover the operator’s
capital investment. A common mechanism for achieving this is where the grantor pays
partly by a financial asset (i.e. the grantor will pay cash for the services provided) but gives