The vast majority of PPP projects in China are concentrated in the infrastructure sector, and infrastructure and public utility concessions represent the most common and widely adopted implementation approach for PPPs. The PPP model involves cooperation between the government and private capital, attracting private investment to achieve win-win outcomes and benefit society as a whole. The more developed the market economy, the greater the room for growth and development under this model.

     Comparison of PPP Domestic and International Accounting Standards

On November 30, 2006, the International Financial Reporting Interpretations Committee (IFRIC) issued International Financial Reporting Interpretation No. 12—“Service Concession Arrangements” (IFRIC 12), which took effect on January 1, 2008. On August 7, 2008, the Ministry of Finance issued Interpretation No. 2 of the Enterprise Accounting Standards (hereinafter referred to as “Interpretation No. 2”). Although this interpretation was not specifically designed for the PPP model, the guidance it provides regarding BOT projects serves as our current reference for conducting related valuation engagements.

The difference between IFRIC 12 and Interpretation No. 2 lies in the scope of the entities they regulate: First, in terms of the entities covered, IFRIC 12 is specifically designed for service concession agreements, whereas Interpretation No. 2 governs BOT projects.

Second, regarding the timing of implementation: IFRIC 12 took effect on January 1, 2008, and was implemented in Europe starting in March 2009. Interpretation No. 2 requires listed companies to begin implementation on August 7, 2008, while encouraging other enterprises to adopt it as well.

Third, the conditions that franchise operations should meet. IFRIC 12 stipulates: A key feature of these service agreements is that the responsibilities borne by the operator have a public-service nature. The purpose of public policy is to ensure that infrastructure-related services can be provided to the public, regardless of who the operator is. The service agreement, in contractual form, guarantees that the operator will provide these services to the public on behalf of the government authorities.

Interpretation No. 2 stipulates: The contracting authority shall be the government and its relevant departments, or enterprises authorized by the government to conduct bidding.

The contractual investor is the entity that has obtained the franchise contract in accordance with the relevant procedures (hereinafter referred to as the “contractual investor”).

The contractual investor shall establish a project company (hereinafter referred to as the “Project Company”) in accordance with applicable regulations to carry out project construction and operation. In addition to obtaining the right to build the relevant infrastructure, the Project Company will be responsible for providing subsequent operational services for a specified period following completion of the infrastructure construction.

The franchise agreement specifies the quality standards for the constructed infrastructure, the construction schedule, the target group to be served after the commencement of operations, the fee structure, and provisions for subsequent adjustments. Additionally, upon expiration of the contract term, the contracting investor is obligated to transfer the relevant infrastructure to the contracting authority, with clear stipulations regarding the infrastructure’s performance and condition at the time of transfer.

Fourth, the recognition criteria for revenue related to franchise business. According to IFRIC 12, the operator shall determine and measure the revenue arising from the services it provides in accordance with International Accounting Standard No. 11—Construction Contracts and International Accounting Standard No. 18—Revenue.

The operator shall account for revenues and costs related to construction or improvement services in accordance with International Accounting Standard No. 11—Construction Contracts. If the operator provides services for constructing or improving infrastructure, it shall recognize the consideration received or receivable at fair value. Such consideration may take the form of rights to the following assets: financial assets or intangible assets.

The operator shall recognize as a financial asset any unconditional contractual right to receive cash or other financial assets from the grantor or under the grantor’s instructions in connection with the construction services provided. The grantor has no or virtually no right to refuse payment, typically because such right is legally enforceable under the agreement.

If the operator obtains a right (license) to charge users of public services, an intangible asset should be recognized. The right to charge users of public services is not an unconditional right to receive cash, since the amount collected depends on the extent to which the public uses the service.

If the operator provides construction services and receives financial assets (waste revenue) for one portion and intangible assets (power generation revenue) for another, it is necessary to account separately for each component of the operator’s consideration. The consideration received or receivable for both components should be initially measured at their fair values as receivables or cash received.

According to International Accounting Standard No. 23—Borrowing Costs, borrowing costs attributable to a contract should be recognized as expenses when they are incurred, unless the operator has, under the contract, the right to acquire an intangible asset (the right to charge users of public services). In such cases, in accordance with the Standard, borrowing costs attributable to the contract should be capitalized during the construction phase of the contract.

The confirmation criteria for Interpretation No. 2 are as follows: During the construction phase, the project company shall recognize the related revenue and expenses for the construction services provided in accordance with "Accounting Standard for Business Enterprises No. 15—Construction Contracts." After the infrastructure is completed, the project company shall recognize revenue related to subsequent operational services in accordance with "Accounting Standard for Business Enterprises No. 14—Revenue."

Construction contract revenue shall be measured at the fair value of the consideration received or receivable, and financial assets or intangible assets shall be recognized concurrently with revenue recognition, depending on the following circumstances.

If the project company does not provide actual construction services but instead outsources infrastructure construction to other parties, it should not recognize revenue from construction services. Instead, it should recognize such payments—based on the contract provisions—as either financial assets or intangible assets, depending on the nature of the payments made during the construction process.

Fifth, the provisions for handling contingent events.

IFRIC 12 stipulates that, as a condition of the concession, the operator may be required to fulfill the following contractual obligations: maintaining the infrastructure at the specified level of service capacity, or restoring the infrastructure to its prescribed condition before transferring it back to the granting authority at the end of the service agreement. These contractual obligations related to maintaining and restoring the infrastructure—except for improvements (which are treated as construction contracts)—shall be recognized and measured in accordance with International Accounting Standard No. 37—Provisions, Contingent Liabilities and Contingent Assets, that is, they shall be measured at the best estimate of the expenditure required to settle the present obligation as of the reporting date.

Interpretation No. 2 stipulates: According to the contract provisions, expenditures expected to be incurred by an enterprise to maintain the service capacity of relevant infrastructure or to keep it in a certain usable condition prior to its handover to the contracting party shall be accounted for in accordance with the requirements of "Accounting Standard for Business Enterprises No. 13—Contingencies."

Sixth, provisions for the treatment of consideration for multiple services provided. IFRIC 12 states that the operator shall determine and measure the revenue arising from the services it provides in accordance with International Accounting Standard No. 11—Construction Contracts and International Accounting Standard No. 18—Revenue. If the operator provides multiple services under a single contract or agreement (i.e., construction or improvement services and operational services), and the amounts attributable to each service can be identified separately, the consideration received or receivable under the agreement shall be allocated based on the relative fair values of the services provided.

Interpretation No. 2 states: According to the provisions of the concession contract, if the project company is required to provide more than one service (e.g., both infrastructure construction services and post-completion operation services), and these services can be separately identified, the consideration received or receivable shall be allocated among the various services in proportion to their respective fair values.

Seventh, regarding the accounting treatment for long-term assets created by the project company: IFRIC 12 stipulates that infrastructure falling within the scope of this Interpretation shall not be recognized as property, plant, and equipment of the operator, because the service agreement does not transfer control of the infrastructure used to provide public services to the operator. The operator is entitled, in accordance with the terms of the contract, to use the infrastructure on behalf of the grantor to provide public services.

Interpretation No. 2 stipulates: Infrastructure constructed under BOT (Build-Operate-Transfer) projects shall not be treated as fixed assets of the project company.

Eighth, the treatment of assets provided other than infrastructure. IFRIC 12 stipulates that the grantor may also provide other items for the operator to retain or dispose of according to its own discretion. If these assets constitute part of the consideration payable by the grantor for the services provided, they do not qualify as government grants as defined in International Accounting Standard No. 20.

They are recognized as assets of the operating entity and are measured at fair value upon initial recognition. For any unfulfilled obligations assumed in exchange for assets, the operating entity shall recognize them as liabilities.

Interpretation No. 2 stipulates: In BOT projects, the grantor may provide the project company with assets other than infrastructure. If such assets constitute part of the contract price payable by the grantor, they should not be treated as government subsidies. When the project company acquires these assets from the grantor, it shall recognize them at their fair value and, prior to providing any services related to the acquisition of these assets, shall recognize them as a liability.

     PPP Assessment Practices and Reflections

In recent years, we have actively participated in several assessment projects under franchise agreements, primarily covering the following areas: water supply, waste management, highways, and others.

Water utility projects include urban domestic wastewater treatment, industrial wastewater treatment in centralized industrial zones, upgraded and enhanced deep treatment, reclaimed water supply, raw water supply, and tap water supply. The main concession models include BOT, TOT (Transfer-Operate-Transfer), BOO (Build-Own-Operate), and ROT (Rebuild-Operate-Transfer), among others.

Waste management projects include sludge reduction, medical solid waste treatment, garbage collection, waste-to-energy incineration, landfill operations, dismantling of end-of-life electrical appliances, and disposal of waste mineral oil. The operational models for these projects are predominantly BOO, though some also adopt the BOT approach.

The highway projects include expressways, toll roads within the province, and bridges; nearly all of these projects are operated under the BOT model.

Other projects include the micro-coal atomization centralized heating (steam) project for industrial parks and the consulting project for the Capital Airport (parking lot and integrated service building). Among these, the micro-coal atomization centralized heating (steam) project for industrial parks primarily adopts the BOT and TBT (Transfer- Build- Transfer) models.

The assessment purposes involved in the above-mentioned areas fall into five main categories: assessment for financial reporting, determination of transaction prices for equity transfers in project companies, pledging of concession rights, tax base assessment, and project consulting. Assessment of PPP projects for financial reporting purposes primarily serves subsidiaries of overseas-listed companies in preparing their annual or semiannual financial reports. Project consulting services mainly cater to TOT projects, assisting the granting authority in setting the transfer price for operating rights.

In evaluation practice, we still have several issues for which we haven't yet found perfect solutions.

First, since the decision-making of social capital depends on the balance between the returns it earns and the risks it assumes, its primary concern is how much profit it can expect from investing in PPP projects and how long the investment will take to pay off. In contrast, the government’s goal is to maximize public interest. Therefore, there is inevitably a conflict of interests between the two parties. How can the default risk faced by the government—acting as the grantor of concession rights—be accurately quantified and reflected in the evaluation model? Second, there is the issue of determining appropriate parameter values across different markets. For instance, Group A is a mainland Chinese enterprise listed on the Hong Kong Main Board. Can we use A-share listed companies as comparable firms to calculate the discount rate? Can we rely on the financial ratios derived from the financial statements of comparable firms prepared in accordance with enterprise accounting standards? Therefore, we recommend that the relevant authorities promptly establish and improve a comprehensive regulatory framework, accounting standards, and evaluation indicator system for PPP projects. Furthermore, we suggest engaging independent third parties to conduct ongoing monitoring and evaluation, with particular attention paid to the following two aspects during the evaluation process.

Is the government ensuring the legality and compliance of its actions—specifically, whether it is including unqualified or substandard projects within the PPP framework, and whether it is reserving high-quality projects for self-reliance while handing over poor-quality or non-revenue-generating projects to private capital?

Are decision-makers in social capital focused on the public interest—especially during the mid- and later stages of a project—by maintaining necessary investments, overcoming short-term behaviors, and ensuring that, upon completion of the project contract, they deliver to the government a high-quality public good that is sustainable and beneficial to society? (This article was compiled by Han Fuheng, our reporter.)