A state government, enters into an arrangement in which it will transfer to the Western Tollway Corporation (WTC) a recently constructed highway. The state reports the highway on its financial statements at its cost of $2 billion. Upon transfer, the state will receive an upfront payment of $4 billion. In return, the WTC will have the right to operate the highway and collect and retain the tolls for a period of 40 years. The company must obtain the approval of the government for any changes in the schedule of toll charges. In addition, the agreement specifies maintenance and related standards that the WTC must meet. It is the policy of the state to depreciate highways over an expected life of 40 years using the straight-line method.
1. Does arrangement satisfy the criteria required for it to be accounted for as a service concession arrangement? Explain.
2. Prepare appropriate journal entries that the state should make at the commencement of the agreement's term to reflect how the transactions would be recorded on its government-wide statements.
3. Prepare appropriate journal entries that the state should make over each of the following 40 years.
4. Suppose that, ignoring inflation, the state estimates that the annual tolls to be collected by the WTA will be approximately $202 million. Alternatively, the state could have issued $4 billion of 40-year revenue bonds that pay interest annually at a rate of 4 percent.
a. Taking into account this very limited financial information, is the state significantly better off entering into the public-private partnership than it would have been by issuing the bonds? Ignore any maintenance and operating costs as well as risks to be incurred by either the state or the WTC. Explain.
b. What may have motivated the state to enter into the PPP rather than issue the bonds?