New Formula for PFI Accounting

1 September 2005

The risk and reward framework that UK PFI operators have been accustomed to is changing. Emma Rodford, of PricewaterhouseCoopers, explains how the new proposals will bring it inline with international financial reporting standards.

The International Accounting Standards Board (IASB) issued its draft interpretations of how to apply International Financial Reporting Standards (IFRS) to service concession arrangements in March 2005.

The guidance is for private sector operators of public-to-private infrastructure service concessions.

It describes how operators should account for the assets they acquire or construct under Private Finance Initiative (PFI) contracts.

It is worth noting that IFRS currently only applies to the consolidated accounts of listed groups, therefore the immediate impact of the draft interpretations is being felt by listed owners of the special-purpose companies set up to operate PFI contracts.

However, over the next few years, it is expected that UK accounting standards will converge with IFRS, gradually widening the reach of these standards to all UK companies.


The International Financial Reporting Interpretation Committee (IFRIC) D12 draft interpretation 'service concession arrangements - determining the accounting model' explains that PFI contracts will fall within its scope if:

  • The public sector grantor controls or regulates what services the operator must provide with the infrastructure, to whom it must provide them and at what price
  • The grantor controls - through ownership, beneficial entitlement or otherwise - the residual interest in the infrastructure at the end of the concession, and the residual interest is significant

If these conditions are met, regardless of the sharing of risks and rewards, the private sector will not be able to recognise a tangible fixed asset. Instead, the operator will have either a financial asset if the public sector pays them or an intangible asset if the general public pays directly.

This approach is very different to the risk and reward framework that UK PFI operators are accustomed to. Under the proposed IFRS framework, the accounting is driven by whichever party controls the asset (regardless of the degree of risk) and who has primary responsibility for paying the operator.

As currently drafted, this could lead to contracts that have almost identical commercial parameters being accounted for in different ways; a shadow toll road would be a financial asset whereas a real toll road would be an intangible asset. Interested parties have raised concerns about this issue in comments to IFRIC.


The impact of implementing the draft standards is potentially severe: under UK GAAP, operators are familiar with accounting for financial assets that are recorded at the cost of the asset.

"The impact of implementing the draft standards is potentially severe."

However, under the financial asset model proposed by IFRIC D13, two different methods of measuring a financial asset are possible: either cost, or more controversially, fair value.

It is extremely unlikely that financial assets arising in PFI concessions will be accounted for at cost, as in order to value assets in this way, the recovery of the asset may only be affected by credit deterioration.

If any other factors could affect recovery, including variability of payments due to demand factors or performance deductions, financial assets must be measured at fair value. As the majority of PFI contracts will include some potential for variability of revenues, it appears likely that most financial assets will be measured at fair value.

In accordance with IAS 39 'Financial instruments: recognition and measurement', movements in fair value will normally be charged to equity leading to volatility in reported net assets and increased visibility of valuations of PFI portfolios.


The draft interpretations do not provide guidance on how the fair value of financial assets should be determined, creating a significant practical difficulty for operators attempting to adopt the standards.

Additionally, the lack of guidance as to how to measure fair value could lead to significantly different approaches and judgements being taken by different operators with a detrimental effect on the comparability of financial statements in the industry.

A related matter for PFI operators is that, under IFRS, financial instruments used by concession companies must also be accounted for under IAS 39. In many cases, there will be a need to fair value hedging instruments, leading to more volatility on an annual basis.


The intangible asset model proposed in IFRIC D14 results in accounting that looks distinctly odd to current UK GAAP users. Revenue relating to the asset is recognised twice - once as the asset is constructed and recognised as an intangible and again when cash is received in the operating phase.

The intangible asset is amortised during the operating phase to offset the extra revenue that is recognised and bring total profits for the concession period under the intangible approach to the same level as would be recognised using a financial asset.

However, revenue is significantly higher if intangible asset accounting is applied. The IASB has debated this uncommon result, but accepted it and asked for comments.

"The draft interpretations do not provide guidance on how the fair value of financial assets should be determined."


Another unusual feature of the intangible asset model is the requirement to provide in advance for future enhancement expenditure, for example the resurfacing of a road - an approach that is not usually adopted under current UK GAAP unless stringent criteria are met.

Under the financial asset model, the IASB regards enhancement expenditure as revenue-related expenditure that is recognised in the period in which it is incurred, matched to revenue received to cover the costs.

Under the intangible asset model, IFRIC has argued that revenue received in the operating phase is not related to enhancement expenditure, therefore the requirement to incur the expense should be viewed as a separate liability and provided for over time.

This accelerates the profit impact of enhancement expenditure under the intangible asset model. Again the IASB specifically asked for comments on this approach, which gives a very different interpretation to the same commercial contract, depending on which accounting basis is being used.

The draft standards provide helpful examples of their application to a financial asset and intangible asset. These show that the two models will lead to significantly different profiles of profit before tax.

The intangible asset recognises losses in the early years of operating the contract as it amortises the intangible and provides for enhancement expenditure, while the financial asset model has a more stable profit profile as its revenues match expenditure.


There is currently uncertainty as to how changes in accounting as a result of implementing the draft standards might impact on tax payable by concessions.

"The standards rule out tangible fixed asset accounting for the majority of PFI contracts."

Changes in profit profiles compared to those modelled under UK GAAP and the impact of fair value movements under the financial asset model are key areas where the tax impact needs to be properly understood and will require discussion with the tax authorities.

The IFRIC draft standards are not applicable to the public sector. However, it is important that the public sector understands their impact as their application may change the commercial terms that operators are willing to accept and impact on value-for-money comparisons.

Additionally, as the standards rule out tangible fixed asset accounting for the majority of PFI contracts, they could result in more assets not held on either private IFRS or public sector balance sheets.