Operating government infrastructure? Is it a service concession?

In the loop , PwC US Jan 08, 2020

What are service concessions?

What you need to know

Operating government infrastructure (bridges, tunnels, toll roads, etc.) could be service concessions.
Although the operator may have legal title or a lease for the infrastructure during a service concession arrangement, the operator should not have the property or lease asset on its balance sheet.
In a service concession, the government is the customer, so any payments to the government for the “right to operate” are reported as a reduction of revenue

For the past decade, US public infrastructure spending has exceeded $400 billion per year¹ and trends suggest that even greater investment will be needed to maintain and upgrade aging roads, bridges, ports, and airport facilities. As governments and public sector entities look for ways to outsource costly public services, they are increasingly turning to service concession arrangements. In a service concession arrangement, a governmental entity grants an operator the right (a concession) to operate an infrastructure asset and to charge and collect fees (e.g., tolls). The fees can be paid by users or directly by the government.

While not all contracts related to infrastructure with a governmental entity are service concession arrangements, it is important to know when they are, because there could be accounting consequences.

_{¹ Shifting into an era of repair: US infrastructure spending trends by Kane and Tomer, Brookings Institute, May 10, 2019}

Is it a service concession arrangement?

In a service concession arrangement, a company is operating an infrastructure asset controlled by a governmental entity. So operating a toll road or an airport likely would be a service concession arrangement. On the other hand, providing a service or selling a good to a governmental entity (e.g., building a courthouse or providing information technology outsourcing) is typically not a service concession. Judgment is often necessary.

To be a service concession arrangement, an arrangement must involve the use of infrastructure assets, and the government must control both the terms of the services to be provided through the use of the infrastructure and any residual interest in the infrastructure at the end of the arrangement.

Does the government control the services?

If the government has the ability to modify or approve the services that the operator must provide under the arrangement (including to whom it must provide them and what price), it controls the services. Typically, the government maintains the authority to determine the nature of the services, to whom they must be offered, the hours of operation of the infrastructure assets, and the fees the operator may charge for use of the infrastructure assets.

Does the government control the residual interest in the infrastructure asset?

The government controls the residual interest in the infrastructure at the conclusion of the arrangement if:

title to the infrastructure reverts back to the government (or never transfers to the operator, such as through the use of a lease that terminates at the end of the arrangement), or
the government has the right to purchase the infrastructure assets from the operator upon termination of the arrangement.

Financial reporting impact

Under ASC 853, a service concession arrangement is accounted for as an outsourcing contract with the government to operate and maintain (and, in some arrangements, construct or improve) the government’s assets. Compared to the reporting for an entity that builds and operates its own asset, service concession reporting may produce significantly different, and unexpected, outcomes for the operator, including:

The operator does not recognize property, plant, and equipment or a lease asset for the infrastructure even though title may transfer to the operator or the arrangement may be structured as a lease. Due to the government’s ultimate residual interest in the infrastructure and control over the terms of the services, the operator is not considered to have the attributes of ownership or control.
The government, not the public users of the facility or recipients of services, is the customer. The operator should determine its performance obligations to the government under the revenue guidance, which could include constructing the asset in addition to providing operation and maintenance services.
Payments to the government are payments to a customer and, therefore, a reduction of revenue. If there are existing infrastructure assets, it is common for the operator to make a significant up-front payment to the government to obtain utilization rights. Any payment made to the government (the operator’s customer) must ultimately be recognized as a reduction of revenue (not as an expense), and is reflected as an operating (not investing) cash outflow.
Under the new revenue standard, variable consideration over the entire life of the arrangement is required to be estimated at contract inception, allocated to each performance obligation in the arrangement, and updated at each reporting period as estimates change. For an arrangement that could last decades, this may present significant challenges. If a company is both constructing and operating the infrastructure, this may also result in recognition of revenue well in advance of the collection of any fees from users as the expected variable revenue would be allocated to each performance obligation and recognized as each is performed. The requirement to update estimates of the variable consideration each period throughout the life of the arrangement could cause fluctuations in revenue unrelated to current period operations.

For more information on service concessions, see chapter 13 of PwC’s Revenue from contracts with customers guide and listen to our podcast.

What qualifies as a service concession arrangement under US GAAP is generally consistent with international accounting standards. However, the accounting can be quite different. See chapter 15 of PwC’s IFRS and US GAAP: similarities and differences guide for information about the differences.