Constructive solutions

Proposed guidance from IFRIC, the interpretations committee, could lead to
significant changes in the way in which PFI contracts are accounted for under
IFRS compared to current UK practice.

The profile of profits could change. Different types of assets could be
recognised. And a fair value approach could introduce accounting volatility.
This will affect the accounts of listed contractors undertaking PFI contracts
directly, and the accounts of listed PFI investors whose equity account for
their interests in PFI special purpose vehicles.

The proposals can best be understood by considering the impact on a 30 year
roads PFI scheme, in which a private sector SPV agrees to construct and maintain
a new road.

Under UK GAAP, the SPV would assess whether it had the risks and rewards of
ownership of the road – in other words, the extent to which its financial return
depended on the number of vehicles using the road.

If the SPV had the risks and rewards of ownership, it would record the road
it constructs on its balance sheet as a fixed asset. Payments from the
government would be recorded as revenue over the period for which the road was
made available for use.

Conversely, if the SPV concluded the government had the risks and rewards of
ownership, it would instead record a financial receivable (a ‘finance debtor’)
due from the government. Cash received from the government would be analysed
between payment of the finance debtor and interest, with the balance being
recorded as revenue for maintaining the road.

Either way, the SPV would generally measure its PFI asset – which might be a
fixed asset or a finance debtor – at historical cost (at least in pre-FRS 26
days). General practice has also been to record most or all of the profit
arising under the PFI contract in the periods in which the road is available for

IFRIC’s proposed guidance on service concession arrangements – generally
known as ‘D12’ at present – is fundamentally different in a number of respects.
Firstly, D12 rejects the risks and rewards approach which underpins so much of

Instead, D12 states that for arrangements within its scope the government –
the ‘grantor’ of the service concession arrangement – retains control of the
physical asset. So the SPV – the ‘operator’ – should not record the physical
road on its balance sheet. There is no ‘tangible fixed asset’ (PPE) model under

Does this mean the road would always be recorded on the government’s balance
sheet, for example? Would the whole of the UK PFI programme be ‘on balance
sheet’ for government under D12? IFRIC has taken care to specify that D12
applies only to private sector operators, not public sector grantors – but
public sector concerns remain.

Secondly, D12 proposes two possible accounting models: the financial asset
model and the intangible asset model.

The financial asset model resembles the familiar UK finance debtor model in
many ways. However, the financial asset is now clearly an IAS 39 financial
asset, which it may be permissible – or necessary – to measure at fair value.

The intangible asset model is new in a UK context. In this model, the SPV
constructs the road in exchange for an intangible asset, being the right to
collect tolls from users. The SPV records revenue on this exchange of dissimilar
assets. When the SPV collects tolls from users this is also revenue for it. As
the SPV records revenue once when building the road and again when operating it,
some have called this ‘double-counting’; the guidance argues it is a consequence
of applying the relevant accounting standards.

Thirdly, D12 originally proposed a ‘who pays?’ test to determine which model
to apply.

Broadly, if the grantor pays the SPV, the financial asset model applies; if
users pay it, the intangible asset model applies. So the SPV would recognise a
financial asset for a road scheme with shadow tolls, and an intangible asset for
a road scheme with real tolls.

To address arrangements where users pay but the grantor guarantees a minimum
level of return, IFRIC has recently debated ‘bifurcation’. Under this approach,
the SPV would record both an intangible asset (representing its right to collect
tolls) and a financial asset (representing its right to receive cash).

The IFRIC guidance also states the operator should recognise profit as it
provides the services, including construction services. This could result in
significant levels of profit being recorded as the road is constructed, in
contrast to the general UK practice of recognising profit largely while the road
is available for use.

Finally, a key issue is whether a given UK PFI contract will meet the
definition of ‘service concession arrangement’, and so fall within the scope of

While a PFI road scheme is likely to be a service concession arrangement, D12
is not intended to apply to all public-private arrangements. In particular,
arrangements in which the grantor itself, rather than the public, uses the asset
could be outside the scope. Where will this leave PFI outsourcing schemes? PFI
defence procurement? One possibility is that they will in part be accounted for
as leases. IFRIC has undertaken to explain further the boundary between service
concession arrangements and leases.

So what are the prospects of the proposals being implemented? The final form
of an interpretation based on the guidance, and its timing, are difficult to
predict. IFRIC has been debating ‘service concession arrangements’ for several
years now and continues to discuss issues raised in response to the draft
version published in March 2005.

Draft documentation released in advance of the committee meeting in April
noted that ‘nearly all respondents expressed concern with fundamental aspects of
the proposals’. However, IFRIC is pressing ahead with its project, as the
responses indicated broad support for the guidance in some form.

So next time you see a road – or a school, prison or hospital – being built,
spare a thought for the accountant who thought she had joined a construction
company but spends her days debating fair values, intangible assets and

Brian O’Donovan is a partner in KPMG LLP

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