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Considering a P3? Consider the new accounting rules too

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As states and cities across the US seek to upgrade infrastructure, public private partnerships (often called P3s or PPPs) are likely to play a critical role, due in part to encouragement from the federal government.

Yet there have been big changes in US accounting rules that could have significant impacts on certain P3s.

The first change came in 2014, with ASC 853, the new rule for service concessions. Many companies now have to account for certain contracts under the revenue recognition standard, rather than recording infrastructure as property, plant and equipment (PP&E) or a lease.

Since ASC 853 came out without much fanfare, some companies initially failed to realize that it would apply to their P3 contracts.

Where ASC 853 applies—and what it means for P3s

ASC 853 applies to contracts in which a public sector entity (from all levels of government: Federal, State, Local, Authorities, etc.) grants a private sector entity the right to operate public infrastructure, such as roads, bridges, tunnels, airports, power plants, universities, hospitals or prisons, if two conditions apply:

  1. The public sector entity controls or has the ability to modify or approve the services the operator provides, to whom, and at what price.
  2. The public sector entity has a beneficial residual interest in the infrastructure after the concession ends.

ASC 853 therefore applies to many P3 operators, but it does not apply, for example, to a P3 arrangement wherein the private participant constructs a power plant or toll road, but does not operate the infrastructure. Since each P3 contract is unique, companies will have to examine the contract, government regulations and legal environment for each arrangement to see if ASC 853 applies.

A P3 operator subject to ASC 853 would apply revenue recognition guidance to the contract, with the government considered the customer. The operator cannot treat the infrastructure as PP&E or the arrangement as a lease, as it does not have the attributes of ownership or control of the asset under US GAAP accounting standards.

Since US GAAP standards on service concessions differ significantly from IFRS, companies that report under both may have to keep two sets of accounting records.

If ASC 853 applies to your contract, and you have to apply revenue recognition guidance, the next thing to know is that this guidance has changed as a result of the new revenue recognition guidance under ASC 606. So even if you have already adopted ASC 853, you should consider further reviewing your revenue recognition accounting policies in light of ASC 606.

The new revenue recognition guidance: Three key implications for P3s under ASC 606

ASC 606 entered into force in 2018 for most public companies and in 2019 for private companies. Our accounting guide, Revenue from contracts with customers, offers, but here are three key considerations that may apply to P3s:

One: Performance obligations

With ASC 606, a performance obligation is now a promise to provide distinct goods or services. Many P3s involve first either constructing or improving existing infrastructure, then operating and maintaining it—often including major maintenance. Depending on the arrangement, each stage of the project lifecycle could contain a distinct performance obligation. For example, a single toll road contract could cover the initial construction, operations and routine maintenance over the life of the contract, and significant repairs or subsequent additions. Determining whether a service concession has multiple performance obligations can be complex and involves significant judgement.

Under ASC 606, at the contract’s start, the project operator must allocate estimated total revenue (transaction price) to each performance obligation, based on what a customer would pay for the good or service on its own (standalone selling price) on a relative basis. As the concessionaire performs each distinct service, it recognizes the previously allocated revenue.

P3 operators subject to ASC 606 may therefore need to recognize revenue long before (or after) they actually collect payments.

Two: Estimating variable consideration

ASC 606 removes the US GAAP restriction on recognizing contingent consideration before the contingency is resolved. That means that many P3 operators will now have to estimate, at the contract’s start, total probable fixed and variable revenue streams. This estimate must account for any expected fixed or variable payments to the government, not received in exchange for a distinct good or service, as a reduction to the transaction price and reflect a constraint, to compensate for possible reversals in revenue.

Such estimates are not easy, especially for contracts that can last multiple decades and have substantial variable pricing. Still, since most P3s involve negotiations, bidding and third-party financing, financial data should be available to help.

The company must use this estimate of total variable consideration to adjust the transaction price, and in most cases allocate that transaction price to all the performance obligations, recognizing revenue as services are performed.

At each reporting date, the company may have to adjust estimates and allocate changes to the performance obligations, which could result in cumulative effect adjustments to previously recognized revenue.

Companies should therefore assess and improve their ability to make estimates, and deploy controls over processes and methods, including whether a single point best estimate or probability weighted method is used to estimate variable consideration.

Three: Standalone selling prices

Since P3 concessionaires now need to calculate standalone selling prices for each performance obligation, they will need the right data to do so. And few companies have this data internally.

Some may look to market participant or industry comparable data, or use costs plus a reasonable margin as an alternative, with the margin based on market data. Yet determining costs for operations or maintenance is complex, especially since they may extend over many years into the future.

Potential P3 operators should assess their ability to accurately calculate standalone selling prices, since these prices are fundamental for allocating the transaction price among the performance obligations.

What to do

Current and potential P3 concessionaires need to understand the new revenue standard (ASC 606) and its broader application to P3s (thanks to ASC 853).

They must then determine if the ASC 606’s new rules apply to their current or potential P3s. If so, many will need new models and sources of data to accurately estimate the total transaction price. Even companies that already have such models may find that they are not suitable for financial reporting, which requires (among other obligations) that models be auditable.

Given the high stakes and the complexity, current or potential P3 operators should assess their P3 accounting resources and expertise, including the need to acquire new technology solutions to meet the new reporting requirements.

Contact us

Darin Siders

Darin Siders

Partner, Capital Projects & Infrastructure, Tax Accounting, PwC US

Peter Ferraro

Peter Ferraro

Partner, Capital Markets and Accounting Advisory Services, PwC US

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