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The
telecommunications industry
The telecommunications industry is a rapidly-changing
industry operating across a broad spectrum,
including simple voice telephone calls, access
to the Internet, high-speed data communications,
satellite communications and the World Wide
Web.
The industry is broadly split in two:
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Fixed-line sector.
A fixed communication network physically
links two or more static devices (telephones,
facsimile machines, computers, television)
by electric cable or optical fibre.
The fixed telephone network was originally
an analogue network that carried voice
traffic only. Technology in the last 20
years has moved towards digital networks.
Operators have invested significant amounts
in the construction of integrated digital
networks that are capable of carrying
data traffic as well as voice.
Each country traditionally had a single
fixed-line operator that was government-owned
or a regulated monopoly. Deregulation
has resulted in the break-up of these
monopolies and the sector has experienced
increased levels of competition and innovation.
The traditional government-owned operators
(most of which have now been privatised)
are referred to as incumbents. The newer
entrants are called alternative network
providers or "altnets".
Incumbents and altnets have constructed
and own their network infrastructure.
There are also service providers who do
not own network infrastructure. These
operators purchase capacity from either
the incumbents or altnets and resell it
to their customers. These service providers
are generally referred to as resellers.
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| b) |
Mobile or wireless sector. Mobile
communications is a relatively new technology
that has been embraced by users and has
become an integral part of our environment
and life-style. The main advantage of mobile
or wireless communication is the user's
mobility, since both the terminal (handset)
used and access to the telecommunications
network are independent of a fixed location.
The term mobile communications refers
to all communication networks that use
radio-based technology. The major differentiation
between a mobile network and a fixed-line
network is the access network. A single
fixed connection point at the customer's
premises is necessary for access to the
fixed-line network, whereas access to
a mobile network is achieved through electromagnetic
radiation within the network's area of
coverage.
The growth in the number of users of
mobile communications has been significant
over the last 15 years. Penetration levels
have reached 70% in many countries. The
mobile sector has also experienced dramatic
technological developments in the last
few years. The next generation (3G, i-mode,
CDMA-2000) of mobile services is available
in a number of countries, offering users
a broader range of voice and data services
over their mobile handsets.
Resellers in the mobile sector are referred
to as Mobile Virtual Network Operators
or MVNOs.
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Intangible assets
Operators continue to carry significant amounts
of goodwill, telecom licences and other intangible
assets on their balance sheets. Many of these
intangible assets were acquired through business
combinations in the 1990s.
Internally-developed software
Technological developments have made possible
the introduction of new product and service
offerings to customers. Many operators have
spent time and money on the development and
customisation of systems to deliver these innovative
products.
IFRS requires capitalisation of internal development
costs is once feasibility is assured .
Telecommunication licences
The cost of mobile UMTS and other next generation
licences represents one of the largest intangibles
on operators' balance sheets. Amortisation of
these licences should commence when they are
"available for use". This will be
the same date on which the underlying network
assets become available for use .
The recoverable amount of telecom licences not
yet available for use should be reviewed annually
for impairment.
Telecom licences should be amortised on a systematic
basis over the best estimate of their useful
lives. The presumption for intangible assets
is that straight-line is the most appropriate
basis of amortisation [IAS38R.97] .Telecom licences are underpinned by
a legal agreement and stated term. The useful
life of a telecom licence will generally be
the period from when the licence becomes available
for use through to the end of its remaining
legal term . A history of renewals
of telecom licences at insignificant cost might
allow the useful life to extend beyond the contract
term, but this would be unusual .
Subscriber acquisition costs
Many mobile operators connect subscribers for service through independent third party distributors or dealers. The dealers are paid a commission for each subscriber connected to the network. The commission amounts vary depending on the type of subscriber connected – post-pay or pre-pay – and the expected quality of the revenue stream associated with the subscriber contract. The costs of acquiring contracts which are identifiable, controlled by a company and meet the recognition criteria of IAS 38R.21-23 should be capitalised as intangible assets.
Initial recognition
Identifiability and control – a post-pay subscriber contract meets the identifiability criterion as it arises from contractual rights [IAS38R.12(b)] The existence of an enforceable legal contract underpins an operator’s ability to control the future cash flows from its post-pay subscribers .
Legal enforceability of a contract is not a necessary condition for control because the operator may be able to control future economic benefits in some other way [IAS38R.13]. However, in the absence of legal rights to protect, or other ways to control, the relationships with subscribers or the loyalty of the subscribers to the entity, the entity usually has insufficient control over the expected economic benefits from subscriber relationships and loyalty for such items to meet the definition of intangible assets [IAS38R.16]. Although pre-pay subscribers do not sign written contracts for service, the economic benefit from the initial sale has already accrued to the operator. Therefore, the costs of acquiring these subscribers will also normally meet the recognition criteria of IAS 38R. However, the amount of the initial card sale is usually small and the expected period over which the card is used is quite short. Subscriber acquisition costs associated with pre-pay customers would, in practice, be amortised over a very short period of time.
Probability of future economic benefits – the future economic benefits flowing from post-pay and pre-pay subscribers is the net cash flows from the provision of telecommunication services. Normally, the price an entity pays to acquire separately an intangible asset reflects expectations about the probability that the expected future economic benefits embodied in the asset will flow to the entity. Therefore, the probability recognition criterion is always considered to be satisfied for separately acquired intangible assets [IAS38R.25]. However, if the projected cash flows are less than the direct costs incurred, then the amount to be recognised as subscriber acquisition costs is limited to the net cash inflows expected from the customer. The operator must be able to demonstrate expected positive cash flows.
Reliable measurement of cost – the cost is the amount of the incremental costs that the operator has agreed to pay for the acquisition of the subscriber. Costs incurred in an operators’ own retail stores are not generally incremental on a subscriber connection basis, and therefore cannot usually be capitalised as an intangible asset, although if the costs are demonstrably incremental, then they may meet the criteria for recognition.
Normally, the operator will be able to measure the incremental direct costs. However, sometimes it is difficult to assess whether an intangible asset qualifies for recognition because of problems in determining the cost of the asset reliably. In some cases, the cost of developing an intangible asset cannot be distinguished from the cost of maintaining or enhancing the entity's internally generated goodwill or of running day-to-day operations [IAS38R.49]. Where the operator is unable to reliably measure the extent to which costs relate directly to the acquisition of customers rather than to general sales and marketing efforts, it may be appropriate to expense all such costs as incurred.
Amortisation of subscriber acquisition costs
The depreciable amount of an intangible asset with a finite useful life is allocated on a systematic basis over its useful life [IAS38R.97]. Customer related intangible assets that arise from a contract shoul be amortised over the period of the contract . The amortisation period includes the renewal period(s) only if there is evidence to support renewal without significant cost [IAS38R.94]. However, the decision to renew is always made by the subscriber and the operator does not have control over the renewal decision. A longer period of amortisation based on the expected period of the overall customer relationship is, therefore, not appropriate.
If the subscriber does renew, and the cost of renewal is significant when compared with the future economic benefits expected to flow to the entity from renewal, the '”renewal” cost represents, in substance, the cost to acquire a new intangible asset at the renewal date [IAS38R.96].
Impairment of subscriber acquisition costs
Customer related intangibles are carried at amortised cost less impairment. Each customer is separately acquired (other than in a business combination) and each related asset is individually assessed for impairment. The operator should have a system that triggers impairment testing in the event of non-payment or less than expected usage on a customer specific basis.
Costs to be included in subscriber acquisition cost
Operators incur a wide range of expenditures in order to secure new customers to their network. However, to meet the criteria for recognition as subscriber acquisition costs, the costs must be direct, incremental costs of acquiring (or retaining) subscribers on the network. In many cases, this will be restricted to the amounts paid to dealers (which may include handset subsidy) which are based on specific subscriber acquisition, although if an operator pays commissions to its own sales force for signing up customers this might meet the criteria.
Increasingly, operators are moving away from paying one-off upfront commissions to dealers when customers are initially signed up, and developing schemes which incentivise the dealers to sign up high value customers to the network. These schemes include revenue share schemes, where the dealer is given an agreed percentage of the airtime revenues generated by the customer. The costs incurred under these types of arrangements are likely to meet the criteria for inclusion in subscriber acquisition costs, as they are direct, incremental costs.
The commitment to make payments to dealers based on revenues generated by the customer (or other similar transactions) will often meet the criteria in IAS 32R for a financial liability and will be required to be recognised under IAS 39R at the inception of the customer contract. The amount recognised will be the fair value of the expected cash outflows to the dealers . Similar transactions include anniversary or renewal commission which are paid to dealers if the customer extends the contract at the end of the initial term.
Property plant
and equipment (PP&E)
The costs of constructing a telecommunication
network range from the cost of purchasing network
equipment and fees paid to third party engineers
to the internal costs of planning and financing
the construction process. The phases of a telecommunications
network's development fall into five stages:
(i) licence bid and preliminary; (ii) network
design and planning; (iii) acquisition and construction;
(iv) commissioning (testing); and (v) post-launch
(operating).
Costs to acquire and install network equipment
are capitalised according to the requirements
of IAS 16R.7. This includes directly-attributable
costs and certain costs incurred during the
pre-operating stages that may be capitalised.
Judgement is required in determining which network
roll-out stage an operator is in, and what expenditure
may be capitalised as part of the initial cost
of constructing the network or is an operating
cost.
Some of the specific issues that may arise include:
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Solution 122.6, Capitalisation of rental
expenses |
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Solution 122.7, Capitalisation of network
planning |
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Solution 122.8, Capitalisation of site
selection costs |
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Most telecommunications networks are constructed
on public land and operators do not typically
acquire legal title to the land. The operators
pay landowners for the right of access to inspect
and maintain the network . The costs of dismantling network assets and restoring
the land to its original condition should be
capitalised as part of the initial cost of constructing
the network .
Network assets are depreciated from the date
they become available for use. The "available
for use" date is often equated to commercial
launch. Commercial launch is not a rigidly-defined
term but is usually interpreted as when the
engineers' sign-off testing has been completed
and the network is capable of providing commercial
services. This is the date when depreciation
should commence .
There is little relationship between the usage
of network assets (traffic carried) and the
rate at which the network is consumed. Network
assets should be depreciated on a straight-line
basis from the date they became available for
use .
Indefeasible Rights of Use ("IRUs")
and capacity arrangements
Many operators enter into IRU and/or capacity
arrangements to minimise the cost of constructing
networks and to accelerate the rate of network
roll-out. This area of telecom accounting received
considerable scrutiny following challenges of
"hollow swapping" (transactions lacking
commercial substance, but structured to achieve
an accounting result). US GAAP, for example,
issued prescriptive guidance on the appropriate
accounting treatment of IRUs and capacity arrangements.
There is no specific guidance on accounting
for IRUs under IFRS. The accounting treatment
is determined by the agreement's commercial
substance. This requires a careful review of
each set of specific facts and circumstances.
Characteristics
and types of an IRU agreement
There is no universally-accepted definition
of an IRU. These agreements come in many forms.
However, the key characteristics of a typical
arrangement include:
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the right to use specified network infrastructure; |
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for a specified term (often the majority
of the useful life of the relevant assets); |
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legal title is not transferred; |
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a number of associated service agreements
including Operations and Maintenance ("O&M")
and co-location agreements. These are typically
for the same term as the IRU; and |
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any payments are made in advance. |
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The main types of IRU and capacity agreements
can be characterised as follows:
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purchase or sale of specified network
infrastructure; |
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purchase or sale of lit fibre capacity;
and |
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exchange of network infrastructure or
lit fibre capacity. |
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Purchase of specified infrastructure
Operators acquire or grant a right to use specifically
identified network assets; for example, empty
ducts or dark fibre pairs. The selling operator
(the "seller") will have negotiated
land access rights with the relevant landowners
and is generally not permitted to assign these
rights to the buying operator (the "buyer").
Hence the seller will generally supervise any
initial cabling and ongoing maintenance that
the buyer undertakes.
The seller does not have any other ongoing
involvement in the use of the network assets.
The buyer determines the specification of the
network, the nature of telecommunication services
provided over the network assets and whether
or not to use the assets.
These agreements are akin to leases in that
they convey a right to use specified network
assets, to the exclusion of other operators,
including the seller. Payment for the use of
the assets is made in advance and does not vary
with the buyer's actual usage.
IRU arrangements that transfer substantially
all of the risks and rewards of ownership to
the buyer should be capitalised as PP&E.
The ongoing involvement of the seller, for example
through the supervision of access, needs to
be assessed in determining where the risks and
rewards of ownership rest.
An IRU often contains multiple elements such
as O&M and co-location agreements. Separate
contracts may be executed for each element,
with flows from the buyer to seller associated
with each separate contract. The contracts must
be considered together when determining cost
of assets acquired and the costs that are operating
expense. The relative fair value of each element
of the arrangement should be determined and
the same proportion of cost ( paid, discounted
as appropriate) allocated to the element. The
IRU assets should be capitalised based on their
relative fair value. The costs of associated
O&M and co-location services should also
be recorded as their relative fair value as
the costs are incurred .
The seller's accounting should mirror the buyer's
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Purchase of lit fibre capacity
The seller grants a fixed-term right to use
a specified amount of its network capacity,
for example, STM-4s or OC-1s. The seller controls
the routing of the buyer's traffic - that is,
the network path from A to B is not fixed or
dedicated to the buyer's use. The seller can
determine which of its network assets (or those
of other operators) terminates the buyer's traffic.
The seller retains a high degree of responsibility
and ongoing involvement in these arrangements.
The buyer should record the cost of the lit
capacity as a prepayment and recognise the cost
of the right to use the capacity on a straight-line
basis over the term of the agreement .
The seller's accounting should mirror that
of the buyer's .
Exchange of network infrastructure
or lit fibre capacity
Telecom operators often exchange network assets
or swap lit capacity. Operators may exchange
payment at the same time, but the net impact
of these arrangements is often neutral.
An exchange of fixed assets with commercial
substance is accounted for at fair value [IAS16R.24].
Commercial substance is determined by assessing
if the entity's flows have changed after
the transaction. An exchange of network assets
without commercial substance is unusual. Any
assets acquired in such an exchange are recorded
at the carrying value of the network assets
given up.
Impairment of network assets and telecom licences
There has been a significant downturn in the
global economy in recent years and the telecommunication
sector has been hard hit, with billions written
off goodwill, telecom licences and network assets.
Impairment indicators
Operators must assess at each balance sheet
date whether there is any indication that an
asset is impaired [IAS36R.9]. External factors
and evidence from internal reporting may provide
indicators that an asset is impaired. Management
should consider both general and telecom-specific
factors, including:
Cash Generating Units
An operator must determine if assets should
be tested separately for impairment or as part
of a cash generating unit (CGU). CGUs are the
smallest group of assets, which include the
asset under review, which generate cash inflows
that are largely independent from other assets
or groups of assets.
The independence of cash flows will be indicated
by the way management monitors the operator's
activities, for example by product lines or
locations. Operators need to consider if the
network can be treated as a single CGU ; if fixed and mobile
businesses can be a single CGU ;
and if the 2G business is independent of the
3G business .
Telecom licences in use do not generate independent
cash flows and should be assessed for impairment
together with the related network assets .
Calculating a CGU's recoverable amount
An asset's carrying value should not be greater
than its recoverable amount, which is the higher
of its value in use or fair value less costs
to sell. The CGU's recoverable amount must be
calculated and compared with its net book value.
There have been few sales of businesses recently
to provide market data on the fair value of
a telecom business. Operators have assessed
the recoverable amount of CGUs by relying on
value in use . As the market
picks up, operators should determine if there
are market transactions to support fair value
estimates.
Forecast Horizon
Value in use is the net present value of the
future cash flows expected to be generated from
the CGU. Cash flow projections should be based
on reasonable and supportable assumptions that
represent management's best estimate of the
range of economic conditions that will exist
over the assets' remaining useful lives or in
the CGU [IAS36R.33]. The projections should
be based on management's most recently approved
financial budgets/forecasts and should not exceed
a period of five years unless a longer period
can be justified. The projections beyond this
point should be extrapolated using a steady
or declining growth rate. These projections
should be extrapolated over the remaining useful
life of the primary asset in the CGU .
Capital expenditure
Future cash flows are estimated for the CGU
in its current condition [IAS 36R.44]. Estimates
of future cash flows should not include amounts
expected to arise from improving or enhancing
the CGU's current performance. Most operators
have significant capital expenditure programmes
in place. Determining whether items of capital
expenditure complete, maintain or enhance the
network asset is often complex. Maintenance
cash flows may be included in the value in use
calculation [IAS38R.49]. Estimated cash outflows
necessary to prepare an asset or CGU in the
course of construction for use together with
the expected cash inflows may also be included
in the calculation of value in use .
Future capital expenditure that extends the
network's reach or enhances its performance
may not be included. Fixed-line operators incur
customer-specific capital cash flows in connecting
customers to their existing network. These costs
are akin to customer acquisition costs, albeit
they meet the capitalisation criteria of IAS
16 (revised). This expenditure and the forecast
incremental revenues may be included in the
calculation of recoverable amount .
Inventories
There is an established practice of operators
selling handsets to customers at a significant
discount. Indeed in many countries handsets
are given free of charge to customers who sign
a service contract (post-pay). Subsidies and
discounts are also given to pre-pay customers.
Inventory is carried at the lower of cost and
net realisable value [IAS2R.9]. Inventory should
be written down to management's best estimate
of the net realisable value at the point a loss
on the sale of the inventory is committed.
Operators should write down inventories of
handsets to their net realisable value at the
balance sheet date. If the operator cannot determine
the net realisable value for specific consignments
of handsets, then a best estimate should be
made, based on the operator's historic evidence
of the level of handsets connected to post-pay
tariffs.
Revenue recognition
Operators' distribution and retail activities
were traditionally straightforward. The fixed-line
and 2G operators provided voice service and
levied a charge on a per minute basis. Revenue
was recognised as the service was provided by
the operator. Today, revenue recognition is
one of the most complex accounting issues the
industry faces.
Deregulation, innovation and competition have
driven complexity in the industry. It has changed
the way the various players contract with each
other to deliver service; for example, content
providers and service providers. Change has
also driven complexity in the service offerings
to customers, in particular for bundled (or
multiple-element) arrangements that may include
a handset set.
Discounts and rebates
It is usual for operators to subsidise telecom
equipment and discount services. Revenue should
be recorded net of any discounts, subsidies
or rebates to customers, or resellers of the
operator's equipment and services .
Service arrangements
The majority of operators' revenues are earned
from the provision of telecommunication services
to attract customers. Revenue should be recognised
as the service is rendered - that is, as the
operator fulfils its obligations to the customer
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Most fixed-line and mobile operators sell prepaid
call cards. Customers pay for the card in advance
and are entitled to a particular number of minutes
over a period of time. The operators are not
earning revenue from the sale of the physical
card. Revenue is earned from the subsequent
provision of telecommunication services. The
advance payments received should be recorded
as deferred revenue. Revenue should be recognised
as the services are rendered - that is, as the
customer uses the credit or on expiry of the
card .
Operators sell prepaid cards without a stated expiry date in some territories. An unused amount, often small, can remain on the cards indefinitely. Revenue is only recognised on the cards as the services are used. If there is no expiry date on the card the operator never extinguishes its responsibility to deliver service. The revenue relating to the unused minutes should not be recognised, even where the operator is able to demonstrate that it is unlikely that the card will be used again .
Principal/agent arrangements
Convergence has been a "buzz word"
in the telecom industry for some time, with
operators seeking to deliver more services and
content through the handset to the consumer.
Operators are increasingly entering into alliances
and revenue share arrangements with third parties
for content and other services. Determining
if the operator is principal or agent depends
on the facts of each arrangement.
A principal should record revenue as the gross
proceeds billed, net of any discounts and sales
taxes. An agent should record revenue as the
net commission earned [IAS18R.8]. It can sometimes
be difficult to determine whether an entity
is functioning as an agent or as a principal.
The standard does not provide any prescriptive
guidance on the determination. Typically, a
principal has:
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the contractual relationship with the
customer; that is, the customer believes
he is doing business with the principal
(e.g. the customer looks to the principal
for "customer satisfaction" issues,
such as warranty claims beyond those provided
by a third party manufacturer and product
returns); |
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the ability to set the terms of the transactions
(e.g. selling price, payment terms etc).
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inventory risk (e.g. loss in value of
handset); |
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credit risk (if the customer defaults,
the principal bears the loss);and |
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responsibility for the collection and
remission of any sales or similar tax that
is imposed on the transaction. |
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The existence of any one of these conditions
is not sufficient evidence that an operator
is acting as a principal. Operators must consider
all of the conditions above when concluding
which accounting treatment to use for principal/agency
arrangements.
There are a large number of principal/agency
relationships in the telecom industry. These
often take the form of revenue share arrangements
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The most common examples of principal/agency
agreements in the industry are inter-operator
interconnect and roaming arrangements. Operators
are normally acting as principals in the provision
of interconnect and roaming arrangements . However, in some countries special
tripartite agreements are commonplace and operators
act an agents on behalf of each other .
Distribution arrangements with third party dealers
Another area where the principal / agency relationship must be assessed is when operators sell equipment through third party dealers. A common example is the sale of mobile handsets through a dealer’s stores. The assessment of whether a dealer is acting as a principal or agent will impact recognition and measurement of revenue.
Where the circumstances of the relationship between the operator and the dealer demonstrate that the dealer is acting as a principal for the sale of handsets the operator should recognise the sale of the handset as a transaction separate from the subsequent acquisition of a customer via that dealer . The cost of the handset should be recognised as a cost of sale at the same time as revenue is recognised.
The substance of the relationship between the operator and the dealer may be that the dealer is acting as an agent for the sale of handsets. The operator should not recognise revenue on any amounts received from the dealer on the initial “sale” of the handset to the dealer . The sale of the handset is recognised when it is sold to a customer and the customer is connected to the network. The operator must assess if the handset sale is a separate transaction which qualifies for immediate recognition, or whether it is linked to the provision of service (Multiple element arrangements - Identification of deliverables that qualify as separate elements.
Multiple element arrangements
The telecom industry is increasingly characterised by the offering of complex bundles as part of a single transaction or a series of linked transactions. Examples include the sale of broadband modems, connection and service in the fixed line sector and the sale of mobile handsets and service contracts in the mobile sector. These arrangements are referred to here as multiple-element arrangements (“MEAs”).
Characteristics of MEAs
MEAs require an operator to deliver telecom equipment and/or a number of services under one agreement, or under a series of agreements which are commercially linked. The package price of the goods or services is generally set below the price at which these items would be sold individually.
Accounting for MEAs
There are three factors which should be considered in determining the accounting for bundled or linked transactions [IAS18.13]. These are:
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Is the commercial effect of the arrangement such that the deliverables should be accounted for separately? |
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If the deliverables are separable, how should the total consideration be allocated across the deliverables? and |
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When should revenue be recognised in respect of each deliverable? |
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The questions raised in 1 and 2 above are considered below. The revenue recognition criteria of IAS 18 should be applied in respect of the sale of telecom equipment and the provision of services.
Separation and linking of contractual arrangements
A MEA should be accounted for as two or more separate transactions (‘unbundled’) where the commercial substance is that the individual deliverables operate independently of each other. This means that each deliverable represents a separable good or service that the operator or another supplier routinely provides to customers on a stand alone basis.
The operator should be able to attribute a reliable fair value to each deliverable by reference to transactions for that item alone, where the various deliverables are to be unbundled. The absence of a reliable fair value for any of the deliverables indicates that the goods and services do not operate independently.
A reliable fair value is not established by a single transaction. A reliable fair value is established by the operator having a regular practice of selling the good or providing the service to customers. A reliable fair value may also be provided by another operator or retailer publishing prices for the good or service separately.
Identification of deliverables that qualify as separate elements
Telecom equipment and service
Telecom equipment typically operates independently from the services provided. Operators sell services separately from handsets and vice versa . Subscribers can also purchase internet modems from retailers and obtain internet access from their telecom service provider. The latest models of 3G handsets can generally deliver 2G (voice and SMS) services on a 2G network.
The sale of the handset or other equipment is not separable from the sale of the service where the service cannot be obtained independently from th | 
