The Federal Ministry of Health established a concession agreement with Howard Limited for the construction of a hospital that will serve a Imosan community of Ogun State, Nigeria. The construction of the project will last two years and the operator will have to manage the hospital for 3 years afterwards, making all 5 years.

The agreement established that the operator must carry out maintenance activities in year 4.

The costs associated with the construction of the hospital are shown below: 

First tranche of construction cost year 1: N50,000,000

Second tranche of construction cost year 2: N60,000,000

Asset operation services (i.e. annual cost of running the hospital): N1,000,000 per annum, from Year 3

Active maintenance in year 4: N9,000,000

Within the bidding agreement, it is established that the operator (Howard) will have the right to collect the following items with their profit margins. 

Construction of the Asset : 7%

Management of the asset 9% 

Maintenance services; 10%

The amounts to be charged by the operator are the following:

The effective interest rate established in the agreement was established at 7.5%.

 

Therefore, agreement gives Howard Limited the right to charge the grantor for the following items:

• The hospital construction
• The operation of the asset
• The maintenance of the asset
• An annual concession fee of N49,552,000 from year 3.

To finance the project, the operator took a 5-year loan for N110,000,000.00 with an annual interest rate of 9%.

How do you account for this transaction over the tenor of the concession agreement, under Financial Asset Method?

Suggested Solution

To solve this problem, you need to first prepare three tables:

• Amortization table for the loan secured.
• Breakdown of annual income and financial asset balances.
• Provisioning for the future maintenance cost in line with IAS 37.

The financing amortization table is as follows:

• Important note: Remember that unlike what applies under Intangible Asset Model, the operator cannot capitalize the interest expense for the first two years when the construction was ongoing, in determining the Financial Asset.

 

- Breakdown of annual income and financial asset balances.

• Remember that under this model, the operator does not charge hospital users any fee for accessing services. This is the prerogative of the grantor. The operator’s entitlement are margins over all the cost incurred including construction cost, operations cost and maintenance cost. The operator is also entitled annual fee as from Year 3. The firm is also entitled to some interest income.
• Also remember the annual concession fee of N49,552,000 from year 3?

 

- Provisioning for the future maintenance cost in line with IAS 37.

• Remember that the operator has obligation to carry out major maintenance work in Year 4 at N9million? Therefore, in line with IAS 37, you need to provision for that from Year 1 till Year 4 when the liability will crystalize.

Now you that you have the key numbers, let us run the proposed Debit and Credit postings:

At initial recognition:

Debit: Bank Account  (with N110m, being the loan disbursement for the project)

Credit: Borrowings Account

After first year-end

1.        Debit: Contract Cost   (With N50million incurred on the project in Year 1)

Credit: Bank Account

 

2.        Debit: Financial Assets (With N53.5million being Gross Income expected from project spend in Year 1)

Credit: Contract Income

3.        Debit: Financial Asset  (With N4.013million being the Interest Income due on the financial asset)

Credit: Finance Income

Remember, the Interest Income applies under this model because the Operator is not entitled to tolls or fees paid by members of the public using the hospital. The interest income is implicit in the annual concession fee payable by the Grantor.

 

4.        Debit: Borrowings Account    (With N18.3million principal repayment in Year 1)

Debit: Interest Expense         (With N9.9million interest payment accrued for Year 1)

Credit: Bank                          (With N28.2million, being the total of loan repayment and interest paid in Year 1)

5.        Debit: Expense for Maintenance Provision  (With N6.7m, being the present value of 9m to be incurred in year 4)

Debit: Interest Expense       (With N505k interest implicit due in Year 1)

Credit: Provision for Maintenance  (With N7.2m being the total provision due for due for Year 1)

 

After second year-end

1.        Debit: Contract Cost      (With N60million incurred on the project in Year 2)

Credit: Bank Account

2.        Debit: Financial Assets    (With N64.2million being Gross Income expected from project spend in Year 2)

Credit: Contract Income

3.        Debit: Financial Asset      (With N4.313million being the Interest Income due on the financial asset)

Credit: Finance Income

Remember, the Interest Income applies under this model because the Operator is not entitled to tolls or fees paid by members of the public using the hospital. The interest income is implicit in the annual concession fee payable by the Grantor.

4.        Debit: Borrowings Account (With N20million principal repayment in Year 2)

Debit: Interest Expense      (With N8.2million being interest payment accrued for Year 2)

Credit: Bank      (With N28.2million, being the total of loan repayment and interest paid in Year 2)

5.        Debit: Interest Expense                (With N543k being interest implicit due in Year 2)

Credit: Provision for Maintenance    (With N543k being interest implicit due in Year 2)

 

After third year-end

1.        Debit: Operations Cost  (With N1million incurred on the operating the hospital in Year 3)

Credit: Bank Account

2.        Debit: Financial Assets  (With N1.09million being Gross Income from operating the hospital in Year 3)

Credit: Operations Income

3.       Debit: Financial Asset      (With N9.45million being the Interest Income due on the financial asset)

Credit: Finance Income

Remember, the Interest Income applies under this model because the Operator is not entitled to tolls or fees paid by members of the public using the hospital. The interest income is implicit in the annual concession fee payable by the Grantor.

4.        Debit: Borrowings Account (With N21.8million principal repayment in Year 3)

Debit: Interest Expense     (With N6.44million being interest payment accrued for Year 3)

Credit: Bank                       (With N28.2million, being the total of loan repayment and interest paid in Year 3)

5.        Debit: Interest Expense      (With N584k being interest implicit due in Year 3)

Credit: Provision for Maintenance   (With N584k being interest implicit due in Year 3)

Since you Howard is now getting paid concession fee in year 3, we will account for this as follows:

6.        Debit: Bank Account        (With N49.5 Concession Fee received in Year 3)

Credit: Financial Asset    

 

After fourth year-end

1.        Debit: Operations Cost  (With N1million incurred on the operating the hospital in Year 4)

Credit: Bank Account

2.        Debit: Financial Assets   (With N1.09million being Gross Income from operating the hospital in Year 4)

Credit: Operations Income

3.        Debit: Financial Asset:    (With 9.9million being maintenance gross income earned in Year 4)

Credit: Maintenance Income

4.        Debit: Financial Asset     (With N6.5million being the Interest Income due on the financial asset)

Credit: Finance Income

Remember, the Interest Income applies under this model because the Operator is not entitled to tolls or fees paid by members of the public using the hospital. The interest income is implicit in the annual concession fee payable by the Grantor.

5.        Debit: Borrowings Account  (With N23.8million principal repayment in Year 4)

Debit: Interest Expense      (With N4.4million being interest payment accrued for Year 4)

Credit: Bank (With N28.2million, being the total of loan repayment and interest paid in Year 4)

6.        Debit: Interest Expense     (With N627.9k being interest implicit due in Year 4)

Credit: Provision for Maintenance    (With N627.9k being interest implicit due in Year 4)

7.        Debit: Provision for Maintenance     (With N9million spent on maintenance as obliged in the agreement)

Credit: Bank Account

Since Howard is getting paid concession fee in Year 4, we will account for this as follows:

8.        Debit: Bank Account        (With N49.5 Concession Fee received in Year 4)

Credit: Financial Asset

 

After fifth year-end

1.        Debit: Operations Cost  (With N1million incurred on the operating the hospital in Year 5)

Credit: Bank Account

2.        Debit: Financial Assets  (With N1.09million being Gross Income from operating the hospital in Year 5)

Credit: Operations Income

3.        Debit: Financial Asset    (With N4.1million being the Interest Income due on the financial asset)

Credit: Finance Income

 Remember, the Interest Income applies under this model because the Operator is not entitled to tolls or fees paid by members of the public using the hospital. The interest income is implicit in the annual concession fee payable by the Grantor.

4.        Debit: Borrowings Account (With N25.9million principal repayment in Year 5)

Debit: Interest Expense     (With N2.3million being interest payment accrued for Year 5)

Credit: Bank                     (With N28.2million, being the total of loan repayment and interest paid in Year 5)

 Since Howard is getting paid concession fee in year 5 also, we will account for this as follows:

5.        Debit: Bank Account (With N49.5 Concession Fee received in Year 5)

Credit: Financial Asset