Brace for Accounting Challenges if There’s An Infrastructure Boom (article)
2019 just might be the year of infrastructure investment. After Democrats took control of the House of Representatives in the November midterms, Democratic leaders and President Trump have voiced support for an infrastructure bill. Aging roadways, and water and public transit systems are a concern for both parties, and the change in the House party leadership could fuel more collaboration in the new year.
Incentives for infrastructure investments could bode well for the construction and engineering sector. It will also bring some additional accounting considerations that shouldn’t be overlooked.
Public works and infrastructure projects are frequently financed and completed through public-private partnerships (P3) where the government entity contracts with private contractors and developers. For accounting purposes, a P3 often meets the criteria to be a service concession arrangement, where the private entity is prohibited from accounting for the infrastructure project as either a lease or as property, plant, and equipment.
Recent guidance from the Financial Accounting Standards Board (FASB) on service concession arrangements, as well as the broader changes to revenue recognition guidance under ASC Topic 606, Revenue from Contracts with Customers (Topic 606), could have an impact on accounting for P3 projects. Contractors should be aware of those potential complications so they can be prepared for the accounting implications should there be a surge in infrastructure project demand.
How Do Contractors Account for a Service Concession Arrangement?
ASC Topic 853, Service Concession Arrangements (Topic 853) applies to agreements between a grantor (usually the government entity) and the operating entity (usually the private contractor or developer) for the operating entity to operate a grantor’s infrastructure (e.g. airport, road, bridge, hospital, etc.) for a set time. “Operate” can include services beyond the day-to-day running of the infrastructure, such as routine maintenance of the infrastructure, or making substantial upgrades to it. Service concession arrangements can be used for infrastructure that is already in place or they can include infrastructure to be constructed by the operator.
Operating entities follow the accounting guidance in Topic 853 when:
- Their grantor has control over the services the operating entity provides with the infrastructure, including who receives the services and the price for those services, and
- The grantor controls any residual interest in the infrastructure at the end of the service concession arrangement.
Infrastructure that qualifies as a service concession arrangement must also be used to provide a public service; a government entity that engages a private developer to construct a government-use-only airport, for example, is not a service concession arrangement. However, the fees the operator receives may come from the governmental entity directly, or be received through charges to the public who receive the service.
Complicating the accounting further is that other accounting guidance may also apply to items related to the arrangement. Equipment and machinery that the operating entity uses as part of operating the infrastructure and that the operating entity retains ownership of after the service concession arrangement ends will be accounted for and capitalized as property, plant, and equipment.
How Does Revenue Recognition Affect Service Concession Arrangements?
Historically, operators that entered into service concession arrangements have had a diversity in accounting practices related to the fees they receive for the services they perform. Recent changes will eliminate some of the diversity in practice.
Determining the Customer in a Service Concession Arrangement
In a service concession arrangement, it may be easy to determine the operator’s customer. For instance, construction and maintenance of the infrastructure would be performed for the owner of the infrastructure, thus making the grantor the customer. However, if an operating entity has a service concession arrangement to operate an interstate toll road, it may seem less clear whether the operator’s customer is the government entity that controls the interstate or the toll road drivers who pay the fee.
U.S. Generally Accepted Accounting Principles (U.S. GAAP) had previously not specified the process an operating entity should follow to determine its customer. The FASB addressed the issue in 2017 with its Accounting Standards Update (ASU) 2017-10, Service Concession Arrangement – Topic 853. It clarified that in all arrangements that meet the conditions for Topic 853 accounting, the grantor is the customer.
Public companies must adopt the standard update for fiscal years and interim periods beginning after Dec. 15, 2017, and private entities for fiscal years beginning after Dec. 15, 2018, and interim periods beginning after Dec. 15, 2019.
Effective dates for ASU 2017-10 mirror the dates for Topic 606, and generally operating entities would adopt both at the same time. If an operating entity early adopted Topic 606, however, additional steps will be involved. The operating entity would transition to the ASU 2017-10 approach using either a modified retrospective approach, recording a cumulative effect adjustment to equity at the beginning of the fiscal year of adoption; or, the operating entity could take a retrospective approach. The transition approach the operating entity uses for revenue recognition does not affect which approach it uses for service concession arrangements. But, if an operating entity used practical expedients to adopt Topic 606, the same practical expedients should be used to adopt the service concession arrangement changes.
Other Repercussions from Topic 606
An operator of a service concession arrangement will be required to apply the five-Step model to its arrangements. Key considerations when applying the guidance in Topic 606 will include determining the performance obligations, estimating the transaction price, and measuring progress on the delivery of services.
- Many service concession arrangements will include more than one performance obligation. For instance, they may include construction of infrastructure, operations, day-to-day maintenance, and upgrades. Each performance obligation would be evaluated to determine if the operator is acting as a principal or agent and each performance obligation will have revenue allocated to it.
- The transaction price for service concession arrangements may include variable consideration, such as fees based on the number of cars traveling on a roadway. These fees will often need to be estimated in order to allocate revenue to the different performance obligations identified in the contract.
- The method of recognizing revenue may be different for the various performance obligations, for instance a construction project may be measured based on the costs incurred compared to the total expected costs, while a monthly maintenance service may be measured based on the passage of time.
- New presentation and disclosure requirements contained in Topic 606 may change the presentation of accounts receivable, and contract assets and liabilities, as well as increase disclosures.
- Additionally, an operator may need to consider the guidance for costs to obtain and fulfill contracts with customers that may change the capitalization and amortization of costs incurred related to the service arrangement.
Look for Help
Operating entities involved in P3 infrastructure projects may want to enlist the help of an accounting provider to ensure they are addressing potential challenges at the onset of any new contracts. For more information, please contact us.
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