Global Accounting and Governance Insights December 2013

Investor Analysis In Latin America Affected By Dual Model Accounting For Infrastructure
Projects
Operators in some countries--such as the U.S.--account for infrastructure projects, including construction
of bridges, toll roads, or tunnels as leases, applying a risk-and-rewards accounting approach: Other
accounting regimes may treat them as property, plant, and equipment (PP&E), applying a controls-
accounting approach. International Financial Reporting Interpretations Committee (IFRIC) 12 “Service
Concession Arrangements” is the first specific guidance for operators on how to account for this important
transaction class under International Financial Reporting Standards (IFRS). Standard & Poor’s Ratings
Services believes there is a need to reduce--if not eliminate--the multiple accounting models under IFRIC
12 that can produce different results for similar economic transactions, requiring further analytical
scrutiny.

Although IFRIC 12 was effective for annual periods beginning on or after Jan. 1, 2008, in Latin America,
the transition is much more recent, as countries there made the transition to IFRS. The primary objective
of IFRIC 12 is to decrease diversity in accounting practice for service concession arrangements; however,
it permits three accounting models. In accordance with its principles, an operator can account for its rights
in a service concession as:
• an intangible asset;
• a financial asset; or
• both (i.e., a bifurcated model approach).

Potential analytical impact and considerations:

• Different Accounting Models For Similar Economic Transactions: Standard & Poor’s Ratings
Services reviewed the accounting model for a sample of companies in Latin America that
changed from local country GAAP to IFRS. We found operators in our sample used a split
between the intangible asset and bifurcated models, while the “pure” financial asset model was
not applied.
• Profitability Assessment Of Service Concession Infrastructure Companies Requires A
Keen Eye: EBITDA under the accounting models differs from year to year over the life of the
arrangement. This difference between the models normally arises because, under the financial
asset model, the income is front-loaded in the early years because of the use of the effective
interest rate method and no amortization of the asset. The intangible asset model likely will have
the opposite consequences, giving rise to lower income in the first few years of the concession
term and higher income in later years.
• Cash-Flow Coverage Metrics Under The Two Models Can Produce Unique Results: For
companies using the intangible asset model, we include investments in intangible assets (for
concessions) as capital expenditures in our analysis. However, the outlier is investments in
financial assets, the inclusion or exclusion of which can potentially skew analytical metrics such
as Free Operating Cash Flow (FOCF)/Debt. In our view, investments in financial assets should be
included as capital expenditures to depict the cash flow adequacy appropriately.
• Service Concessions Cash Flows Are Not Always Reported As Operating Activities:
Construction of PP&E does not give rise to revenue, whereas construction of infrastructure under
the intangible asset or financial asset model under IFRIC 12 gives rise to revenue. Hence, it is
more appropriate to classify the service concession cash flows as operating activities. In practice,
however, we have noted the classification of cash flows related to service concessions in
company financial statements as investing activities, financing activities and/or operating
activities. This also implies there could be a potential impact on Cash Flow From Operations
(CFO)/Debt.

3
 • Multiple Accounting Frameworks In Latin America Add To The Challenge: Companies in
Latin America that report in accordance with local-country GAAP (e.g., Colombian GAAP), may
continue to report service concessions as PP&E or other assets and amortize these assets over
the term of the service concession arrangement. Additionally, under U.S. GAAP, there is no
specific accounting guidance that addresses accounting for service concessions. It is therefore
critical to understand the accounting and determine whether to make analytical adjustments
accordingly, at least until all countries in Latin America have transitioned to IFRS.

For the full article, please see the following link:

How Dual Model Accounting For Infrastructure Projects Affects Investors In Latin America, dated
December 2, 2013.

"Key Credit Factors For The Transportation Infrastructure Industry,” published Nov. 19, 2013.