The business impact
Impact on the telecom sector
Most telecom companies are both lessors and lessees. Typical agreements in which telecom companies act as a lessee include leases of land (including sites for mobilemasts), buildings, equipment and vehicles. Other agreements that could qualify as leases include capacity contracts, wayleaves and rights of access, satellite broadcasting contracts and IT outsourcing agreements.
Telecom companies may also act as lessors of telecom equipment or may fall to be treated as lessors in network outsourcing agreements or data centre activities.
The magnitude of the impact of the proposed lease accounting model will depend on which of the above agreements fall within the scope of the new standard. Given the large number of (smaller) leases and options that are generally included in site leases and outsourcing agreements, implementation of the standard is likely to require significant resources and effort.
Response from the telecom sector
In March 2009, the Boards issued a joint discussion paper which set out preliminary proposals in respect of lessees. A number of telecom companies provided input to the Boards in the form of comment letters in response to the 2009 discussion paper. In this paper we have summarised their key comments and observations and how the Boards have responded in the recent exposure draft.
Overall, most telecom companies agreed with the general direction in which the Boards were heading. Although not all operators were convinced that the current model was significantly flawed, the proposed right of use model was considered a reasonable approach given some of the issues that users have with current accounting. Many operators however believed that the increased complexity and use of estimates would not add to the overall reliability and transparency of the financial statements. They raised concerns about whether the benefits outweigh the costs.
Scope of the project
Most respondents to the discussion paper argued that the Boards should work on a comprehensive lease standard, dealing with both lessee and lessor accounting (the discussion paper addressed only lessees). The exposure draft includes proposals in respect of lessor accounting, the main provisions of which are set out on the previous page.
Telecom companies also argued strongly that the new lease standard should be developed consistently with ongoing changes to the conceptual framework and other crucial standards such as revenue recognition and financial statement presentation.
Also on the subject of scope, telecom companies believed that the Boards should take the opportunity to reconsider the guidance regarding arrangements that contain a lease. The current guidance (IFRIC 4 ‘Determining whether an arrangement contains a lease’) is generally considered by telecom companies to be difficult to apply in practice and can result in inconsistent conclusions about whether an arrangement contains a lease or not. The Boards have however incorporated the principles of IFRIC 4 into the exposure draft.
Short-term and non-core leases
Most telecom companies agreed with the Boards that no distinction should be made between leases of core and non-core assets. However, they believed that exclusion of certain short-term leases may be appropriate based on materiality. In the exposure draft the Boards have proposed that for leases with a maximum possible term (including all extension options) of less than 12 months, lessees can use a simplified form of accounting. No other exemptions have been proposed.
Contingent rentals and renewal options
Telecom companies generally disagreed with the proposed approach to contingent rentals and renewal options. Their principal argument was that recognition of a liability for payments that are avoidable is not consistent with the definition of a liability in the conceptual framework and other accounting standards. They also believed that a requirement to estimate whether renewal options will be exercised at specific points in the future contradicted the business reasons for seeking agreements with flexibility in the first place. Finally, they noted the significant administrative cost involved, volatility in the income statement and lack of reliability.
As an alternative, telecom companies proposed to limit measurement of the lease obligation to the unavoidable contractual payments to be made during the noncancellable period, with enhanced disclosure about contingent rentals, renewal options and other uncertain elements.
The Boards believe the inclusion of contingent rentals and renewal options informs investors about expected cash flows and that the current requirements generally exclude these items making it more difficult for investors to estimate future cash flows. For this reason in the exposure draft the Boards continue to propose that contingent rentals and renewal options are included in the measurement of lease liabilities. They have changed their perspective as to how those amounts should be estimated, but this is unlikely to address the specific concerns of telecom companies.
Revision of estimates
The discussion paper proposed that estimates were to be revised at each balance sheet date. Most telecom companies believed that revision of estimates should be limited to specific circumstances because the administrative burden of continuous re-assessment would be too great. They also believed that lessees should not be required to revise the lease liability for changes in the incremental borrowing rate. The lease liability should however be re-assessed if new events indicated that there is a material change in the expected lease term or lease payments.
All responding telecom companies agreed that changes to the estimated lease obligation should be reflected in an adjustment to the right of use asset and not result in a gain or loss in the income statement.
In the exposure draft the Boards have proposed that a reassessment will only be required where there have been changes in facts and circumstances that indicate that there is a significant change in the liability to make lease payments or the right to receive lease payments.
Where the change in estimate relates to prior periods it should be recorded in the income statement. Where it relates to future periods an adjustment should be made to the right to use or right to receive.
Telecom companies had mixed views about whether the right of use assets and lease liabilities should be presented separately on the balance sheet or only in the notes. They generally agreed that the decrease in value of the right of use asset should be presented as depreciation or amortisation in the income statement. This is in line with the proposals in the exposure draft.