Votes on Matters Discussed on 3 June 2004
On the first day of the meeting the IFRIC had been unable to form a quorum for large parts of the day due to three of the members being in attendance at the IASCF Constitutional Public Hearings in New York. At the beginning of the second day the staff outlined the major conclusions drawn on day 1 in respect of D3 Determining Whether an Arrangement Contains a Lease, and D7 Employee Benefit Plans with Promised Returns on Contributions or Notional Contributions. The IFRIC was asked to vote on the decisions in respect of these items as described above, and the motions were carried.
IFRS 2, IAS 19, and Employee Benefit Trusts
The IFRIC considered two draft interpretations amending the scope of SIC-12 Consolidation – Special Purpose Entities. The first interpretation proposes to delete the scope exclusion for equity compensation plans. The second proposes to delete the scope exclusion for equity compensation plans and to extend the scope exclusions relating to post-employment benefit plans to also exclude other long-term employee benefit plans. The IFRIC were in agreement that the second alternative was preferable, but believed the urgency to be placed on the deletion of the equity compensation plan scope exclusion was sufficient that if they were unable to determine appropriate wording for the second proposal that the first proposed draft interpretation should be issued.
The IFRIC debated the objective of the second proposed amendment, and agreed that it was to explicitly exclude employee benefit plans from consolidation when the accounting for those plans is already mandated by IAS 19. Following this debate the staff proposed the following scope exclusion paragraph be used:
This Interpretation does not apply to post-employment defined benefit plans and other long-term employee benefit plans with plan assets that are required to be included in the measurement of a defined benefit liability or a liability for other long-term employee benefits in accordance with paragraphs 54 and 128 of IAS 19 respectively.
The IFRIC agreed that, subject to editorial comments, the suggested scope exclusion paragraph was appropriate, and agreed that the draft interpretation incorporating this paragraph be sent to Board members for comment and, subsequent to that process, issued with a 75 day comment period.
The IFRIC were presented with a number of papers on service concessions covering the following topics:
- Service concession assets - a control perspective
- The intangible asset model and the alternatives
- Detailed accounting issues on the alternative models
At previous meetings, the IFRIC had identified three potential models for accounting for service concessions:
- The physical asset model: On completion of construction the concession operator recognises the physical asset as its own.
- The receivable model: On completion of construction the concession operator recognises a right to receive cash as a result of the construction of the physical asset (the control of the physical asset passes to the concession provider).
- The intangible asset model: On completion of construction the concession operator recognises an intangible asset – effectively the licence to operate the physical asset (the control of the physical asset passes to the concession provider), as a result of its construction activities.
Service concession assets – a control perspective
The IFRIC debated a paper that considered, from a control perspective, which party should recognise the infrastructure assets as its own. The paper suggested that in the context of a service concession arrangement, CP (the Concession Provider), controls a property owned by CO (the Concession Operator) if CP (including parties related to it) both:
(a) controls or regulates what services CO must provide using the property, to whom it must provide them, and at what price; and
(b) will control, through ownership, beneficial entitlement or otherwise, the residual interest in the property at the end of the concession.
CP might also control a property owned by CO in other circumstances.
The IFRIC expressed general discomfort with these principles, including a concern that the model may not be consistent with existing GAAP, particularly in cases where CO is to operate an existing asset rather than construct a new one. They debated the merits of this proposal at length, particularly the practical application of the price control criteria. They determined that the items mentioned in the paper certainly formed a list of indicators that control might rest with CP even where legal ownership rests with CO, but not all were convinced that the criteria cited above should be used in the eventual interpretations. However, the IFRIC agreed to use the criteria above as its working model, with the intention that these criteria will be revisited once they have been tested, along with the other proposals, against examples.
The intangible asset model and the alternatives
The IFRIC debated a paper which proposed that the intangible asset model will apply most commonly in practice. The physical asset model will seldom apply because, on the basis of the control analysis discussed earlier, the physical asset will normally be on the books of CP. The receivable model will apply in situations where CO has a right to receive cash (the right to operate the road and thus derive cash does not result in a receivable). Therefore in most circumstances the intangible asset model will apply. A majority of IFRIC members tentatively supported this model. All were keen, however, to see the model tested against a variety of examples before reaching their final conclusions.
The basic illustration of the intangible asset model used is:
- CO constructs a road with a cost to construct of 100.
- The fair value of the road at the completion of construction is 110.
- Operating costs over the life of the concession are 70, and cash inflows will be 200.
- At the completion of construction CO transfers the road to CP and receives as consideration an intangible asset – the licence to operate the road.
- As this is a transfer of dissimilar assets (a road for an intangible), it must generate revenue measured at fair value of the asset given up in accordance with IAS 18. Therefore CO recognises revenue of 110, an intangible of 110, and therefore has a profit on construction of 10.
- Over the life of the concession CO receives 200 in cash, and pays 70 in operating costs, and amortises the intangible asset of 110, resulting in a profit of 20. Therefore total revenues for the contract are 310, and total profit is 20.
A number of IFRIC members were very concerned about the recognition of the 110 revenue on completion of construction, as it seemed counterintuitive to them that an entity could recognise revenue and a profit on construction of an asset to be used in its own activities. However, most IFRIC members conceded that, although they were uncomfortable with this, an exchange of dissimilar goods and services does occur at the completion of construction, and accordingly revenue (and consequently profit or in other circumstances loss) on the transaction must be recognised.
Two IFRIC members indicated their intention to dissent from the interpretations if the interpretations conclude that total revenues on the concession of 310 should be recognised. The staff agreed to consider for IFRIC's debate at a future meeting, whether the use of the intangible asset model absolutely necessitated the recognition of the 110 construction revenue, or whether there might be some way in which the total revenues recognised under this model were equivalent to the total cash flows (that is, in the example above, 200).
The papers presented to the IFRIC also contemplated the accounting for transactions by CP. The IFRIC debated whether they should address the accounting by CP, given that CP is often a public sector entity that in many jurisdictions would not apply IFRS. The IFRIC concluded that contemplating the accounting by CP was useful in testing the appropriateness of the proposals by CO, and also noted that in some transactions and jurisdictions CP would be required to apply IFRS.
The IFRIC discussed at what point under the intangible asset model, the intangible asset should be recognised. The options presented to them were:
- Recognition of an intangible on day 1 with a corresponding liability reflecting the outstanding construction obligation.
- Recognise a receivable over the period of construction which is then recognised as an intangible at the completion of construction.
- Recognise an intangible asset over the period of construction.
The IFRIC generally favoured the recognition of a receivable over the period of construction in cases where revenue would be recognised on the construction phase, and recognition of an intangible over a period where no revenue would be recognised on the construction phase. Accordingly final conclusions on this are dependent on the final conclusions about the appropriateness and operation of the intangible asset model. The IFRIC did note that where a receivable was recognised that would be settled other than in cash this would need to be distinguished from other receivables that are financial assets in the balance sheet.
The IFRIC considered the accounting for restoration obligations. The staff had suggested that obligations to construct new assets, or enhance new or existing assets to a condition better than at the start of the concession should be recognised as part of the cost of the intangible. This was differentiated from the situation of subsequent expenditure generally under IFRS, because it is actually a cost of obtaining the licence to agree to these obligations, and IFRIC generally supported this approach.
Where general restoration obligations exist, it was proposed that these be recognised over the life of the concession arrangement. This would mean amounts recognised at a particular point in time may be positive or negative depending on where in the restoration cycle the entity is. The IFRIC expressed some discomfort with this view, and that they believed it amounted to income smoothing. However, they did agree that at a point in time an assessment should be made as to whether any restoration obligation exists and if one did it should be recognised with the corresponding expense being recognised in profit and loss.
The IFRIC then went on to discuss some examples and whether they were in agreement with the application of the models to those examples. They concurred that subject to further exploration of revenue recognition issues described above, the staff had accurately applied the models to the few examples they were able to examine before the available time for the discussion expired.
Because of time constraints the IFRIC did not get an opportunity to discuss:
- How CP should account for its sale of the intangible asset.
- The treatment of finance costs.
- The treatment of assets contributed by CP to CO.
- The impact of other contractual obligations of CO.
The staff will proceed with preparing draft interpretations for consideration at the July meeting, on the basis of decisions taken to date.
This summary is based on notes taken by observers at the IFRIC meeting and should not be regarded as an official or final summary.
Scroll down for notes from 3 June 2004.