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13198864 Jason Sheedy

ASR Assignment 1: Transurban Holdings Ltd

JASON SHEEDY 13198864 Accounting Standards and Regulations 22420 Word count: 1199

13198864 Jason Sheedy

Executive Summary This report for Transurban Holdings Ltd (TCL) explores the current accounting framework in relation to the toll road concession industry and explores potential impacts of the deterioration of the toll road industry. TCL is a road operator that manages road in Australia, North America and Canada and was founded in 1996. Hypothetically, if road traffic were to decrease TCL would face a deterioration of their financial stability, as revenue and their asset’s fair values drop.

Part A: With reference to TCL, identify and summarise the accounting policies relating to toll road concessions and how these are dictated by regulation. Revenue AASB 15 applies to all customer contracts except those covered by standards such as financial instruments, leases and insurance. AASB 15 aims to provide an accurate financial reporting system to recognise revenues to reflect considerations entities are entitled to in return for completing performance obligations. The standard establishes a five-step model to achieve it’s requirements for a contract with customers (AASB 15). For TCL, AASB 15 overrules AASB 118 Revenue, AASB 111 Construction Contracts and their relevant interpretations, dictating how TCL must recognise revenue (TCL, 2018). Toll prices can be found online or advertised on signs before their respective road. When customer enter and exit at the toll points on the road, thereby using the road, a performance obligation is then satisfied, and revenue can be recognised.

AASB Interpretation 12 Service Concession Arrangements (AASBI 12) AASB INT 12 incorporates IFRIC 12 Service Concession Arrangement that establishes a framework for the accounting management of intangible and financial assets (TCL, 2018). A service concession arrangement is when the public sector arranges with the private sector to build, maintain or operate their infrastructure, such as roads, prisons and airports, for a period of time.

13198864 Jason Sheedy

TCL mainly classify their concessions using the intangible asset model, with $21390 million (TCL, 2018) worth of intangible assets compared to $323 million of concession financial assets (TCL, 2018). The classification of concessions is dictated by whether the government gives the right to pay any shortfall in revenue (financial asset) or when that right is not given (intangible asset). Paragraph 45-47 of AASB 138 provide guidance for the measurement of the intangible asset (AASB INT 12). This interpretation applies to all entities required under to provide financial reports and statements under the Corporations act 2001 (paragraph AUS27.1 AASB INT 12).

Part B: With reference to TCL, identify and explain the flexibility management has available in the determination of asset values underpinning the toll road business. The predominant asset valuation method used is the discounted cash flow analysis, aggregating cash flows over the lifetime of the asset and calculating the net present value of those minus residual value. Three important characteristics that determine the value of toll roads are the remaining years until the concession agreement terminates, the change in toll prices and demand (Magellan Financial Group, 2019). If TCL were to use an Enterprise Value (EV) to Earnings Before Interest, Tax, Depreciation and Amortisation (EBITDA) ratio, slight changes to toll price and traffic growth increases can have vast impacts on the asset valuation (Magellan Financial Group 2019). Magellan presented how the value of toll road concessions can be influenced by changing toll price and traffic growth. They found that if toll prices were to increase 1% above inflation and for traffic growth to increase by 4% p.a. from their base model, that EV/EBITDA would be nearly 50% bigger at a concession length of 30 years, shown in this graph. Therefore, showing the large flexibility at the discretion of management.

13198864 Jason Sheedy

When TCL determines when an intangible asset fair value is less than it’s carrying amount, the asset is considered impaired and it amortised. This impairment amount is recorded as an expense in their profit and loss (TCL, 2018). TCL calculates the fair value using assumptions about expected traffic flows, forecasted operational costs, long term CPI growth, long term average weekly earnings growth and a pre-tax discount rate. Traffic volumes are calculated using the TCL’s group long term traffic forecasting models which are based on historical trends. These models are formulated internally and therefore TCL have the ability to skew the statistical formulae of the models towards their desired outcomes, giving management some flexibility with intangible asset valuations. However, within this model, the CPI, long-term weekly growth earnings growth and pre-tax discount rates are gathered from independent external forecasts, meaning there is no flexibility to use these to TCL’s advantage.

13198864 Jason Sheedy

Part C) With reference to TCL, explain the potential impacts of any deterioration of the toll road business on the financial reports of TCL (i.e., balance sheet and income statement impacts). Deterioration in the toll road market would have a negative flow on effect to TCL’s financial statements. A decrease in toll revenue would first impact cash flow and revenue, making it harder to repay their current obligations. It would also impair their intangible assets because they are revalued each year based upon their future economic benefit (TCL, 2018). This would mean that they would have a decreased amortisation and depreciation expense, potentially increasing their accounting earnings and therefore their tax payable. All their financial ratios will also be affected by these changes. Revenue from the toll industry makes up 98% (TCL, 2018) of TCL’s revenue, making their financial health of their financial reports heavily reliant on well-being on the industry. TCL has $15395 carrying amount of consolidated debt (TCL, 2018), accumulating net finance costs of $722 million for the 2018 financial year. If TCL’s revenue were to drop, it would make it harder to repay their obligations. Potentially causing them to miss their interest repayments perpetually increasing their debt amount, possibly causing them to incur more debt to repay their current obligations. TCL in 2018 have $20108 (TCL, 2018) million of concession assets which are valued based upon their expected future economic value. If the toll road industry were to deteriorate this would cause their concession assets to become impaired from the decrease in future cash flows from the roads. High asset values increase the disparity between accounting earnings and generated cash flows from higher depreciation and amortisation costs each year (Magellan Financial Group, 2019). Amortisation and depreciation expense in 2018 was $671 million (TCL, 2018) would decrease in correlation with the amount of impairment. This could possibly mean their tax payable could go up and will mean that their total assets and equity will go down on the balance sheet. These effects on the financial statements will deteriorate many of TCL’s financial ratios, as the effects of less revenue is at the core of most healthy financial ratios.

13198864 Jason Sheedy

d) If oil prices were to substantially increase and thereby reduce the usage of private motor vehicles (until sufficient alternative-energy vehicles could be manufactured at scale), evaluate the potential economic consequences of the changes in TCL’s financial statements you identified in part (c). This should be answered using the accounting theory related to the use of financial reports (Week 0 material) A surge in oil prices would cause a large reduction for the demand for tolls as consumers switched to substitute products. This would vastly impact all business and government that own toll road concessions from a substantial drop in revenue. Therefore, having cascaded negative impacts for TCL as their financial statements and stability, examples mentioned above, as they would slowly crumble as investors debt contracts constraints may be jeopardised (Wells, 2002). And thus, potentially change the current travel industry due to changing consumer preference.

If TCL were to breach their debt contract with their investors, this could cause their financial stability to spiral down into insolvency. TCL may have had to negotiated certain debt, solvency and profitability ratios with their debt holders in return for lower interest charges (Wells, 2002). TCL’s assets and equity drastically decrease as mentioned above. Breaching these clauses in their agreements will cause higher interest repayments, placing the company in an even worse financial predicament.

Being placed in this position could force TCL to adopt some drastic business strategies to stay solvent. First, they may need to lower their toll prices to become more competitive and to drive demand for toll roads. Or sell the toll road concession to another company similarly to how they purchased the Cross-City tunnel.

The decrease of car consumption can potentially influence the government's decisions. Toll road concession and toll prices may need to decrease to reflect the change in demand. Financial concession asset may become more appealing to encourage businesses to enter the toll road market. Or alternative products such as high-speed railway systems may become more appealing to government to produce rather than roads.

13198864 Jason Sheedy

References Abbott, M. and Tan-Kantor, A. (2019). Asset valuation of government business enterprises: a reevaluation of pricing issues. [online] Swinburne University of Technology. Available at: https://www.cpaaustralia.com.au/~/media/corporate/allfiles/document/professional -resources/education/asset-valuation-government-business-enterprises.pdf?la=en [Accessed 21 Sep. 2019].

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(2019). 2018

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[Accessed

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https://www.aasb.gov.au/admin/file/content105/c9/AASB138_0815_COMPjul17_01-20.pdf [Accessed 21 Sep. 2019].

Magellan Financial Group. (2019). What is a toll road worth? - Magellan Financial Group . [online] Available at: https://au.magellangroup.com.au/insights/what-is-a-toll-roadworth/ [Accessed 22 Sep. 2019].

Revenue from Contracts with Customers. (2019). AASB 15. [online] AASB. Available at: https://www.aasb.gov.au/admin/file/content105/c9/AASB15_1214_COMPsep18_01-19.pdf [Accessed 19 Sep. 2019].

Service Concession Arrangements. (2015). AASB Intrepretation 12. [online] AASB. Available at: https://www.aasb.gov.au/admin/file/content105/c9/INT12_08-15.pdf [Accessed 20 Sep. 2019].

Wells, P., 2002, Earnings management surrounding CEO changes, Accounting & Finance 42, 169-193.

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