IFRS Solutions

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The links that follow provide exclusive access to specific accounting solutions for the Telecommunications industry.

Introduction to applying IFRS for telecommunications entities

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:

  1. 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.

  2. 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.

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 (Solution 122.1).

Telecommunication licences
The cost of mobile UMTS and other next generation licences represents one of the largest intangibles on operator's 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 (Solution 122.2). 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 [IAS 38 (revised) para 97] (Solution 122.3). 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 (Solution 122.4). 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 (Solution 122.5).

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 38 (revised) para 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 [IAS 38 (revised) para 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 (Solution 122.39).

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 [IAS 38 (revised) para 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 [IAS 38 (revised) para 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 38 (revised). 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 [IAS 38 (revised) para 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 [IAS 38 (revised) para 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 [IAS 38 (revised) para 97]. Customer related intangible assets that arise from a contract should be amortised over the period of the contract (Solution 122.40). The amortisation period includes the renewal period(s) only if there is evidence to support renewal without significant cost [IAS 38 (revised) para 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 [IAS 38 (revised) para 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 32 (revised) for a financial liability and will be required to be recognised under IAS 39 (revised) at the inception of the customer contract. The amount recognised will be the fair value of the expected cash outflows to the dealers (Solution 122.41). 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 16 (revised) paragraph 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:

  • Solution 122.6, Capitalisation of rental expenses (Solution 122.6)
  • Solution 122.7, Capitalisation of network planning (Solution 122.7)
  • Solution 122.8, Capitalisation of site selection costs (Solution 122.8)

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 (Solution 122.9 ). 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 (Solution 122.10) (Solution 122.11) (Solution 122.12).

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 (Solution 122.13).

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 (Solution 122.14).

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:

  • the right to use specified network infrastructure;
  • for a specified term (often the majority of the useful life of the relevant assets);
  • legal title is not transferred;
  • 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
  • any payments are made in advance.

The main types of IRU and capacity agreements can be characterised as follows:

  1. purchase or sale of specified network infrastructure;
  2. purchase or sale of lit fibre capacity; and
  3. exchange of network infrastructure or lit fibre capacity.

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 cash 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 (cash 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 (Solution 122.15).

The seller’s accounting should mirror the buyer’s (Solution 122.36).

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 (Solution 122.16).

The seller’s accounting should mirror that of the buyer’s (Solution 122.37).

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 cash impact of these arrangements is often neutral.

An exchange of fixed assets with commercial substance is accounted for at fair value [IAS 16 (revised) para 24]. Commercial substance is determined by assessing if the entity’s cash 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 [IAS 36 (revised) para 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:

  • adverse trends in performance indicators such as network utilisation rates, Average Revenue Per User (ARPU), the number of customers, churn and Cost Per Gross Addition (CPGA);
  • network operating or maintenance expenditure significantly in excess of original budget;
  • significant shortfall of revenues compared to budget or prior periods;
  • technological developments that may reduce the economic performance of the licence (i.e. the technology related to the licence becomes obsolete);
  • impact of changes in regulation and deregulation; and
  • increases in market interest rates.

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 (Solution 122.17) (Solution 122.18); if fixed and mobile businesses can be a single CGU (Solution 122.19); and if the 2G business is independent of the 3G business (Solution 122.20).

Telecom licences in use do not generate independent cash flows and should be assessed for impairment together with the related network assets (Solution 122.21).

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 (Solution 122.22 ). 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 [IAS 36 (revised) para 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 (Solution 122.23).

Capital expenditure
Future cash flows are estimated for the CGU in its current condition [IAS 36 (revised) para 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 [IAS 38 (revised) para 49]. Estimated cash outflows necessary to prepare an asset or CGU in the course of construction for use together with the expected cash nflows may also be included in the calculation of value in use (Solution 122.24).

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 (Solution 122.25).

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 [IAS 2 (revised) para 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 (Solution 122.26) (Solution 122.27).

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

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 (Solution 122.30).

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 (Solution 122.31).

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 (Solution 122.42).

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 [IAS 18 (revised) para 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:

  • 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);
  • the ability to set the terms of the transactions (e.g. selling price, payment terms etc);
  • inventory risk (e.g. loss in value of handset);
  • credit risk (if the customer defaults, the principal bears the loss); and
  • responsibility for the collection and remission of any sales or similar tax that is imposed on the transaction.

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 (Solution 122.32) (Solution 122.33).

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 (Solution 122.34). However, in some countries special tripartite agreements are commonplace and operators act an agents on behalf of each other (Solution 122.35).

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 (Solution 122.43). 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 (Solution 122.44). 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 (122.8.5 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 [IAS 18 para 13]. These are:

  1. Is the commercial effect of the arrangement such that the deliverables should be accounted for separately?
  2. If the deliverables are separable, how should the total consideration be allocated across the deliverables? and
  3. When should revenue be recognised in respect of each deliverable?

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 (Solution 122.45) (Solution 122.46). 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 the purchase of the telecom equipment. The operator will need to consider whether the arrangement is only one service contract for which revenue should be spread over the life of the service or whether the arrangement it has with the customer is in substance a contract for service and a lease arrangement over the equipment in accordance with IFRIC 4 Determining whether an Arrangement contains a Lease.

Connection
Many fixed line and mobile service offerings include a charge for connection. Frequently, it will not be possible to demonstrate that the connection fee is in respect of a service which is operating independently from the service arrangement with the operator (Solution 122.47).

There are circumstances where it will be possible for the operator to demonstrate that the connection is operating independently from the other services (Solution 122.48).

This could be the case in a deregulated fixed line environment, where one operator provides the connection and another operator provides the service.

Promotional offers
It is common practice to offer free products to subscribers to encourage them to sign up to a contract; common free products have included DVDs or other electrical goods. These promotional offers are not separable revenue generating deliverables for the operator. All the revenue under the contract is revenue for the provision of telecommunications services and equipment.

Operators should recognise the cost of these free products as a marketing expense. No revenue should be allocated to these services (Solution 122.49).

Complex tariffs
It is common practice for the service offering to subscribers to include a number of different elements – voice, MMS, SMS content downloads – on one tariff. The significance which is attached by analysts to the different elements in the results of operators means that the allocation of total consideration across the different elements is important (Solution 122.50).

Allocation of total consideration received or receivable
Revenue in a multiple element arrangement is recognised at the fair value of the consideration received or receivable in respect of each separable element. The recognition criteria in IAS 18 are usually applied separately to each transaction. However, in certain circumstances, it is necessary to apply the recognition criteria to the separately identifiable components of a single transaction in order to reflect the substance of the transaction. Conversely, the recognition criteria are applied to two or more transactions together when they are linked in such a way that the commercial effect cannot be understood without reference to the series of transactions as a whole [IAS 18 para 13].

IAS 18 does not offer any practical guidance on how this principle should be applied in practice, particularly in light of the fact that the consideration received for the bundle is often less than the sum of the value of the individual elements. As revenue should be recognised at the fair value of the consideration received, the “discount” that the customer obtains by buying all the components should be applied rateably based on available fair values.

Operators often offer significant discounts on the equipment. Therefore, the subscriber only pays a small amount at the time of sale in comparison to the value of the equipment received. An allocation of the total consideration of a MEA determined according to the relative fair value of the equipment and service may result in a larger amount of consideration being allocated to the equipment. The cost of the equipment is recognised at the same time as the related revenue (Solution 122.45).

IRUs and capacity arrangements
Accounting for the purchase and sale of IRUs and capacity arrangements is considered in section 122.5 above. The sellers accounting for the sale of specified network infrastructure (Solution 122.36) and the sale of lit capacity (Solution 122.37) should mirror that of the buyer.

The exchange of lit network capacity that is similar in nature and value does not give rise to the recognition of revenue (Solution 122.38).

Attention: This guidance is based on the revised standards and interpretations that are mandatory for accounting periods commencing 1 January 2005. A company may early adopt an individual revised standard, but only in its entirety.

Capitalisation of rental expenses

Issue
The cost of an item of PP&E comprises, inter alia, any costs directly attributable to bringing the asset to the location and condition necessary for it to be capable of operating in the manner that management intends [IAS 16 (revised) para 16].

Should an operator capitalise rental expenses?

Background
Operator A is constructing a section of its mobile network. A has entered into cell site rental agreements with various landowners to locate the cell site equipment. A pays 1,000 a month for the rental of the cell sites. A will pay the same level of rental expense after the network is launched.

Solution
Operator A should expense the rental of 1,000 as incurred throughout the network’s construction stage.

Site rental costs will be incurred before and during the network operating stage. The costs are not incremental and they are not directly attributable to the process of bringing network assets to their working condition. Therefore, they should be expensed as incurred.

The rentals are part of the start-up costs, which should be expensed as incurred [IAS 38 (revised) para 69].

Lease payments under an operating lease should be recognised on a straight-line basis over the lease term unless another systematic basis is representative of the time pattern of the user’s benefit [IAS 176 (revised) para 33]. A derives benefit from the lease from day one, because it has access to the site in order to install its equipment. Therefore, the straight-line basis of recognising the lease payments is appropriate. Rentals incurred before the network is operational should not be capitalised.

Capitalisation of network planning

Issue
The cost of an item of PP&E comprises, amongst others, any costs directly attributable to bringing the asset to the location and condition necessary for it to be capable of operating in the manner that management intends [IAS 16 (revised) para 16].

Should an operator capitalise network planning costs?

Background
Operator B is considering extending its network footprint. As part of the feasibility study, B’s network design and planning department has drafted three possible routes over which the network could be rolled out. The department has also estimated the potential cost of each route. The costs the department will incur in providing this analysis include internal time of 10,000 and external costs of 5,000.

Solution
Operator B should expense the 15,000 the network design and planning department incurred.

IAS 16 (revised) paragraph 7 provides that in determining whether an item satisfies the criteria for asset recognition, it is necessary to assess the degree of certainty attaching to the flow of future economic benefits on the basis of the available evidence at the time of initial recognition.

The costs incurred during the initial feasibility study, which include identifying specification requirements and the selection process, should be expensed as incurred. The flow of economic benefits to B as a result of the work of the network design and planning department is uncertain.

Capitalisation of site-selection costs

Issue
The cost of an item of PP&E comprises, amongst others, any costs directly attributable to bringing the asset to the location and condition necessary for it to be capable of operating in the manner that management intends [IAS 16 (revised) para 16].

Should an operator capitalise site-selection costs?

Background
Operator C is building out its third generation network. C must install a base station within a certain geographic area (cell site). Siting the mast within each cell will depend on a number of factors, including the ability to get planning permission and the costs of developing the selected site.

C employs a third party company to search for the preferred base station location. The third party typically examines 6 or 7 potential locations in parallel and recommends the preferred site. C builds its base station on the recommended site.

The company employed to search for the base station location charges C 5,000 per site.

Solution
Operator C should capitalise 5,000 as part of the cost of constructing the network.

The selection of a base station location that meets the technical conditions required for the optimal operation of the network (e.g. coverage, quality of reception) is an inherent part of the process of bringing network assets to working condition for their intended use. C pays the contractor to locate a site and then uses the site. The directly-attributable costs associated with the site selected may be capitalised.

Software development costs

Issue
An intangible asset is recognised if probable future economic benefits from the asset will flow to the entity and the cost of the asset can be measured reliably [IAS 38 (revised) para 21].

The probability of future economic benefits is assessed using management’s assumptions of the economic conditions that will exist over the asset’s useful life [IAS 38 (revised) para 22].

When should an operator capitalise internally-developed software?

Background
Operator A is considering upgrading its billing system. A completed a feasibility study that considered several software systems before deciding whether to go ahead with the upgrade. A subsequently decided to upgrade its billing system.

The development will take six months to complete. A will use internal resources to customise the software. The total cost is expected to be 250,000, including 10,000 for the feasibility study, 25,000 to train the personnel who will be using the billing system and 215,000 of labour time for those personnel who were dedicated to the customisation and upgrade of the billing system.

Solution
Operator A should expense the costs of 10,000 associated with the feasibility study and the training costs of 25,000 as incurred. The direct personnel costs of 215,000 should be capitalised as part of the cost of the new billing system.

A must capitalise the cost of customising the software as part of the cost of the software, provided:

  1. it has the resources to complete the project;
  2. the software will be used in operating the business; and
  3. it is probable the system will generate future economic benefits

The costs that may be capitalised are those directly attributable to the project, including the salaries of personnel directly engaged on the project. Costs that are not necessary for the development of the software, such as the feasibility study, are expensed as incurred. Training costs are never capitalised, because employees do not represent a resource controlled by the organisation.

Commencement of amortisation of telecom licenses

Issues
The depreciable amount of an intangible asset with a finite useful life shall be allocated on a systematic basis over its useful life. Amortisation shall begin when the asset is available for use – that is, when it is in the location and condition necessary for it to be capable of operating in the manner that management intends [IAS 38 (revised) para 97].

When should an operator commence the amortisation of its telecom licence?

Background
Operator B purchases a telecom licence in 1999 for 1 million. The licence has a term of 12 years. B then constructs its telecom network. The telecom network is capable of delivering service in 2001, two years after the licence was initially purchased. The licence has a remaining term of 10 years.

Solution
Operator B should commence amortising its telecom licence from the date the network, and hence the licence, is available for use – that is, in 2001. B should undertake an annual impairment review in the years when the licence is not being amortised.

The depreciable amount of an intangible asset is allocated over the best estimate of its useful life [IAS 38 (revised) para 97]. An asset’s useful life is defined as "the period of time over which the asset is expected to be used by an entity".

The telecom licence is capable of being used on the date it is purchased, but cannot be used until the associated network assets necessary are available for use. Amortisation of the licence should commence when the associated network assets are available for use.

Basis of amortising telecom licences

Issues
An intangible asset’s depreciable amount should be allocated on a systematic basis over the best estimate of its useful life [IAS 38 (revised) para 97].

What basis of amortisation should an operator adopt in respect of its telecom licences?

Background
Operator C purchases a telecom licence in 1999 for 1 million. The licence has a term of 12 years. C’s network assets are ready for use in 2001. The telecom licence has a remaining term of 10 years from the date the underlying assets are ready to use.

C expects its subscriber base to grow over the next few years and reach a critical mass in four years’ time - that is, 2005.

Solution
Operator C should amortise the full value of the licence on a straight-line basis over its remaining term of 10 years.

The amortisation method should reflect the pattern in which the entity consumes the asset’s economic benefits [IAS 38 (revised) para 97]. The licence does not suffer wear and tear from usage (i.e. the number of customers using the service). The economic benefits of a licence relate to C’s ability to benefit from the use of the licence. The economic benefit consumed relates to the fact that a period of time has passed and that the useful life of the licence is now shorter by that period. Accordingly the asset depletes on a time basis and the straight-line basis of amortisation is the most appropriate one. The presumption for intangible assets is that straight-line is the most appropriate basis of amortisation [IAS 38 (revised) para 98].

Period of license amortisation

Issues
The depreciable amount of an intangible asset with a finite useful life shall be allocated on a systematic basis over its useful life [IAS 38 (revised) para 8 ]. An intangible asset’s useful life is the period over which the asset is expected to be available for use, or the number of production or similar units expected to be obtained from it [IAS 38 (revised) para 97].

Rights with a limited term that can be renewed may have a life longer than the original contractual period. The intangible asset’s useful life includes the renewal periods only if there is evidence to support that it can be renewed without significant cost [IAS 38 (revised) para 94].

Over what period should an operator amortise its telecom licence?

Background
Operator D purchased a telecom licence in 2000 for 1 billion. The licence has an initial term of 10 years. The licence agreement is silent about D's right to renew the licence. While D expects to be able to renew its licence at the end of its initial term, it is not known what charge, if any, the government would make for such a renewal.

Solution
Operator D should amortise the full value of the licence on a straight-line basis over 10 years. D plans to renew the licence, but it has no experience of the government renewing telecom licences. It cannot reliably determine what amount, if any, would be payable to the government for the renewal of the licence, the likelihood of renewal or any related costs.

Period of amortisation

Issues
The depreciable amount of an intangible asset with a finite useful life shall be allocated on a systematic basis over its useful life [IAS 38 (revised) para 8]. An intangible asset’s useful life is the period over which an asset is expected to be available for use, or the number of production or similar units expected to be obtained from it [IAS 38 (revised) para 97].

Rights with a limited term that can be renewed may have a life longer than the original contractual period. The intangible asset’s useful life includes the renewal periods only if there is evidence to support that it can be renewed without significant cost [IAS 38 (revised) para 94].

Over what period should an operator amortise its telecom licence?

Background
Operator E purchased a telecom licence in 2000 for 1 billion. The licence has an initial term of 10 years. The licence agreement is silent about E's right to renew the licence. There is an established practice of the regulator granting a single renewal of telecom licences at no additional cost provided operators adhere to the requirements of the licence.

The licence requires E to meet certain network build milestones, to provide service to a fixed percentage of the population and to adhere to any new regulations issued. E has already met the first two criteria and management intends to comply with new regulations as and when they are issued.

Solution
Operator E should amortise the full value of the licence on a straight-line basis over 20 years. There is experience in E's country of the regulator renewing licences for one additional term at no cost to the operator. E has met the conditions of the licence and intends to continue to adhere to any additional requirements the regulator sets out.

Rights of way and easements to access land

Issues
A lease is an agreement whereby the lessor conveys to the lessee, in return for a payment or series of payments, the right to use an asset for an agreed period of time [IAS 17 (revised) para 4].

Should an operator account for the right to access land as a lease?

Background
Operator D makes a one-off payment of 1,000 and monthly payments of 100 to the local government for access to its land. The right of way contract is for a term of 20 years. There is no stated right of renewal, and legal title to the land remains with the local government.

Solution
Operator D should classify the payment of 1,000 as a pre-payment on the balance sheet. The pre-payment should be charged to the income statement on a straight-line basis over the life of the right of way. The monthly payments should be recorded as an expense as incurred.

A characteristic of land is that it normally has an indefinite economic life. If title is not expected to pass by the end of the lease term, then substantially all of the risks and rewards incident to ownership have not been transferred. The right of way has only been granted for 20 years; D has not acquired substantially all of the risks and rewards of ownership, hence the lease of land should be accounted for as an operating arrangement.

Asset retirement obligation – fixed-line operator

Issues
The initial cost of an item of PP&E includes the initial estimate of the costs of dismantling and removing the item and restoring the site on which it is located. [IAS 16 (revised) para 16].

How do telecom operators determine whether or not a present obligation exists with respect to asset retirement obligations?

Background
Operator E is a fixed-line operator that is currently constructing a subterranean network. E is obligated to reinstate the land should the entity cease to be a going concern or decide to withdraw from operating within a certain region. E’s licence has an indefinite term.

E is a going concern and currently has no plans to withdraw its operations from any regions.

Solution
E should make a best estimate of the provision for any costs that are expected to be incurred in the reinstatement of the land. The present value of the reinstatement provision should be capitalised as part of the initial cost of constructing the network. Operator E has a legal obligation under the terms of its licence to reinstate the land. The obligation arises at the point when E constructs its network - that is, at the point "damage" to the land caused by the roll-out of the network has occurred. In making this assessment, E should take into account:

  • the likely timing of any reinstatement of land; and
  • the expected costs.

The forecast costs should be discounted back to present value using a pre-tax rate that reflects the risks specific to the obligation.

Asset retirement obligation – mobile operator

Issues
The initial cost of an item of PP&E includes the initial estimate of the costs of dismantling and removing the item and restoring the site on which it is located [IAS 16 (revised) para 16].

How do telecom operators determine whether or not a present obligation exists with respect to asset retirement obligations?

Background
Operator F is a mobile operator. F leases a cell site and builds a base station on the site. F is required to reinstate the land at the end of the lease (either the end of the lease term or an earlier date if both parties agree to an early termination of the lease). The lease term is 20 years. The base station equipment has a useful life of 10 years. F expects to relocate the base station at the end of the 20-year lease term. F estimates that the discounted present value of site reinstatement costs is 5,000.

Solution
Operator F should make a provision of 5,000 in respect of the expected cost of reinstating the cell site. The provision should be capitalised as part of the initial cost of constructing the base station.

F has a legal obligation under the terms of the lease to reinstate the land. The obligation arises at the point when F constructs its network, when the "damage" to the land caused by the roll-out of the network has occurred. The obligation will crystallise at the end of the lease in year 20.

The forecast costs should be discounted back to present value using a pre-tax rate that reflects the current market assessment of the time value of money and the risks specific to the obligation. 5,000 is the present value of the cost to reinstate the cellsite in year 20.

Period of depreciation of asset retirement obligations

15/09/2010

Issues
The depreciable amount of an item of property, plant and equipment should be allocated on a systematic basis over its useful life [IAS 16 (revised) para 6].

An asset’s useful life is defined as the period of time over which an asset is expected to be available for an entity’s use, or the number of production or similar units expected to be obtained from the asset.

Over what period should an operator depreciate an asset retirement obligation?

Background
Operator J is a mobile operator. Operator J leases a cell site and builds a base station on the site. Operator J is required to reinstate the land at the end of the lease (either the end of the lease term or an earlier date if both parties agree to an early termination of the lease).

The lease term is 50 years. Operator J expects to relocate the base station at the end of the lease term. The base station equipment has a useful life of 10 years and the concrete base on which the mast and base station equipment erected has a useful life of 20 years. Operator J has calculated an asset retirement obligation of 2 million, of which 0.5 million relates to the decommissioning of the base station equipment and 1.5 million relates to the reinstatement of the site.

Solution
The asset retirement obligation relates to the physical assets on the site as the operator will incur the decommissioning expenses when it removes the assets. Operator J should allocate the asset retirement obligation to the components of the base station and depreciate it according to the useful life of the related components.

A significant part of the obligation arises upon the removal of the concrete base and not when the base station equipment is decommissioned. It is not appropriate to depreciate the full provision over 10 years or over the lease term of 50 years.