ASSURANCE GAZETTE

December, 2024
Contents

Foreword Accounting Presentation of interest payable

Treatment for and depreciation for earlier years
ESCO Projects in the Statement of Profit and Loss.
Foreword

We are thrilled to present the December 2024 edition of

the Assurance Gazette. This edition offers insights for
professionals in financial reporting, auditing, and
compliance.
This edition focuses on Energy Service Companies (ESCOs),
emphasizing their role in energy efficiency and
sustainability. It covers key accounting treatments under
Indian Accounting Standards (Ind AS), including Ind AS 115,
116, and 16. Our goal is to guide professionals in adopting
sustainable financial practices while addressing
ESCO-related challenges.
Additionally, this edition also captures the examination of
the accounting treatment of interest payable
and depreciation in the context of a joint venture's
termination dispute. It highlights the necessity for proper
classification and disclosure in financial statements,
ensuring compliance with Ind AS standards and
providing clarity to users on exceptional items and routine
expenses.

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Accounting Treatment for
ESCO Projects

An Energy Service Company (ESCO) offers energy solutions aimed at optimizing energy usage, improving efficiency, and reducing costs. Through
services such as energy audits, efficiency upgrades, renewable energy installations, and ongoing energy management, ESCOs help clients achieve
significant savings, reduce environmental impact, and promote sustainability. These services are tailored to meet the specific energy needs of
different sectors, including commercial, industrial, governmental, and institutional.

ESCOs operate under three main business models:

Performance-Based Contracts: Shared Savings Contracts: The Energy Performance Contracts (EPC): The ESCO
ESCO and client share the finances, installs, and designs energy-efficient systems,
Compensation is tied to actual
energy savings, with the ESCO with repayments based on the savings generated.
energy savings achieved.
receiving a portion.

Revenue streams for ESCOs are primarily categorized into two types. The first is upfront revenue, which includes income earned at the start of
the project, such as equipment sales and consulting fees. The second is ongoing revenue, which refers to continuous income tied to the
performance of energy-saving measures, including payments for energy management and maintenance services.

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Accounting Treatment under Indian Accounting Standards (Ind AS)
Applicable IND AS are IND AS 115 “Revenue from contacts with customers”, IND AS 116 “Leases”, IND AS 16 “Property, Plant and Equipment”.

IND AS 116 “Leases”

ESCO shall check the contract for classification under IND AS 116 “leases”. IND AS 116 defines lease as, "A contract, or part of a contract, that
conveys the right to use an asset (the underlying asset) for a period of time in exchange for consideration."
Further it provides some conditions to be fulfilled by a contract to be identified as a lease contract. These conditions are listed below:

Right to Control the Use of an Asset

The contract must convey the right to control the use of an identified asset for a specified period. This
means that the lessee must have the ability to direct how and for what purpose the asset is used during the
lease term.

Identification of an Asset
The contract must involve an identified asset, either explicitly specified or implicitly specified at the time
the contract is signed. The asset must be physically distinct or identifiable (e.g., a specific building or piece
of machinery).

Most ESCO projects are more focused on providing a service (energy savings, efficiency, etc.) than transferring the control or use of an asset,
which is why they do not qualify as leases under IND AS 116. Instead, these projects are often accounted for under IND AS 115 (Revenue from
Contracts with Customers), where the focus is on revenue recognition based on the delivery of services rather than the transfer of an asset.

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 IND AS 115 “Revenue from Contracts with Customers”

IND AS 115 provides 5 step models to recognize the revenue 1. Identify the Contract, 2. Identify Performance Obligations, 3. Determine the
Transaction Price, 4. Allocate the Price and 5. Recognize Revenue.
Revenue streams are broadly categorized into two main types based on their sources:
02
Revenue generated from government authorities,
Revenue generated directly from the public, such as
including income from streetlight projects and energy-
collections from tolls or charging stations.
saving initiatives for buildings.
01

IND AS 115 applies to ESCO projects that are structured as service contracts rather than leases. In such cases, the revenue recognition is
driven by the provision of energy services, such as energy savings, monitoring, and maintenance. The revenue is recognized as the
performance obligations are satisfied over time, aligning with the principle that revenue should reflect the transfer of services to the
customer. The specifics of each ESCO agreement, including performance guarantees and the timing of revenue recognition, must be carefully
considered to apply IND AS 115 correctly.

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 IND AS 16 “Property, Plant And Equipment”

IND AS 16 specifies following two conditions to be fulfilled by an asset to be classified as PPE:

The cost of the asset can be reliably measured, including

It is expected to bring future economic benefits to the all costs incurred to bring the asset to its current condition
entity (such as revenue generation or cost savings). and location for use.

It further states that cost of PPE includes purchase price of the assets, cost directly attributable to the assets and expected dismantling cost,
if any.
The asset or infrastructure developed by ESCO vest with the client but, the ESCO has right on the future economic benefits of the asset and
the same should be accounted for as per IND AS 16 so, the cost of the infrastructure should be capitalized and to be depreciated over the
useful life of the project or agreement, as ESCO normally transfer the assets to the user at the end of the agreement.

Nangia’s Take

ESCOs represent a transformative approach to sustainable development, seamlessly integrating economic incentives with
environmental solutions. Their innovative revenue models, spanning government partnerships and direct consumer services,
showcase a sophisticated approach to energy infrastructure. The intricate financial mechanisms underlying these projects
highlight the complex yet promising landscape of sustainable technology investments. As the energy sector continues to evolve,
ESCOs stand at the forefront of driving meaningful ecological and economic progress.

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Presentation of interest payable and depreciation
for earlier years in the Statement of Profit and Loss.

Facts of the case presented before EAC Queries Posed before the EAC

A joint venture between the Government of India and the Government of the National Capital
Territory of Delhi proposed the Airport Line project as a Public-Private Partnership (PPP). The
Concession Agreement was signed on August 25, 2008, and a Special Purpose Vehicle (SPV), D Whether aforesaid
Ltd., was formed to operate the Airport Line for 30 years before handing it over to the accounting
Corporation.
treatment given by
On May 23, 2012, D Ltd. identified defects in the Corporation’s work and ceased operations by the Company was If not, what was
July 8, 2012. D Ltd. issued a notice on July 9, 2012, giving 90 days to rectify defects or face correct.
termination under the agreement. Despite repairs by the Corporation, D Ltd. claimed the the correct
defects were not resolved within the stipulated period, issuing a termination notice effective accounting
January 7, 2013. The dispute escalated to arbitration. On May 11, 2017, the Arbitral Tribunal treatment?
upheld D Ltd.'s termination claim, awarding Rs. 2,992.49 crores (including Rs. 2,782.33 crores
as Termination Payment) with interest. The Supreme Court affirmed this decision in September
2021.
For FY 2021-22, the Corporation capitalized the termination payment as of the termination
date, charging associated interest and depreciation as exceptional items in its financial
statements. Earlier, it had disclosed the liability as contingent for FY 2020-21.

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Company’s Contention:

Asset Allocation: The Arbitration Award did not provide a detailed asset-wise break-up of Rs. 2,782.33 crores. As per Ind AS 103
01 ('Business Combinations'), this amount was allocated to individual identifiable assets on a pro-rata basis, based on their relative
values as per I Ltd.'s report.

Execution Petition: D Ltd. filed an Execution Petition with the Hon’ble Delhi High Court on 10.09.2021 for Rs. 7,045.41 crores.
02 Hearings are ongoing, which challenges the assertion that the capital cost for creating various classes of Airport Line assets is
limited to Rs. 2,992.49 crores.

Provision under Ind AS 37: Since the capitalisation amount for the Airport Line remains unascertainable, the company cannot
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recognise various asset classes corresponding to the liability of Rs. 2,992.49 crores, contrary to the Audit's suggestion.

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Synopsis of EAC considerations
Materiality and Disclosure:
According to Ind AS 1, Classification of Interest and
information is material if its Depreciation: Interest payable,
omission, misstatement, or arising as a finance cost in the
obscuration could influence the normal course of business, should
decisions of primary users of not be classified as exceptional.
financial statements. Material Similarly, depreciation, though
and infrequent items must be accumulated from earlier years,
disclosed as line items or notes arises in the ordinary course of
to enhance understanding of business and should also not be
Presentation of Exceptional Items: financial performance. Definition of Exceptional Items: considered exceptional.
As per Schedule III of the Companies Exceptional items must pass the
Act, 2013, exceptional items must be tests of materiality and
presented separately in the infrequency. As per paragraph
Statement of Profit and Loss. Finance 98 of Ind AS 1, such items are
costs and depreciation must be material, infrequent, and
presented under their respective line require distinct presentation for
items in expenses, and additional clarity.
details of exceptional items should
be disclosed in the notes.

The presentation of interest payable to D Ltd. and depreciation under "exceptional items" in the Statement of Profit
and Loss for FY 2021-22 was inappropriate. Instead, these items should be presented under their respective heads,
Conclusion
"finance cost" and "depreciation," with disaggregated headings or subtotals if their magnitude or frequency warrants
it, along with suitable disclosure in the notes for better clarity on financial performance.

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Meet our Experts

Vikas Gupta Prateek Agarwal Vikram Singh Pratap Jaspreet Singh Bedi Vijaya Uppiretla
Partner - Audit & Assurance Partner - Audit & Assurance Partner - Audit & Assurance Partner - Audit & Assurance Partner - Audit & Assurance
vikas.gupta@nangia.com prateek.agarwal@nangia.com vikram.pratap@nangia.com jaspreet.bedi@nangia.com vijaya.uppiretla@nangia.com

With inputs from: Our Offices

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