IFRS 16 and the Telecommunication Industry

The PwC Global Lease Capitalisation study published in February 2016 indicated that there would be a median debt increase of 21% for Communications companies (due to the recognition of lease liabilities).

IFRS16 (effective from Jan 2019) will fundamentally change the accounting for lease transactions and is likely to have significant business implications.

Telecommunications industry is among the entities that are most likely to be affected by the changes as most of them enter into lease agreements both as lessors and lessees. They also enter into a variety of contracts for the right of use or access a portion of a network system. For example, designated space on mobile towers, pole attachments, capacity in fibre cables and co-location space within central space.

Such companies will need to analyse contracts where equipment is provided to their customers. In such cases, consideration should be given to

  1. whether the contract contains a lease and
  2. separating the lease and the non-lease components (unless the entity applies the practical expedient)

The asset that is subject of a lease must be specifically identified. This will be the case if either of the below apply:

  1. The asset is explicitly specified in the contract or
  2. The asset is implicitly specified at the time that is made available for use by the customer. (IFRS16)

Identifying a lease will sometimes require a significant amount of judgement based on the definition of the lease. For example,

While dedicated space on a mobile tower would be an identified asset, a capacity portion of an asset that is less than substantially all of that asset's capacity would not be an identified asset because it is not physically distinct from the remaining capacity of the asset.

'Some contracts involve a dedicated cable that is part of the larger network infrastructure. IFRS 16 does not specify that these arrangements are identified assets. However, the FASB's new standard has an additional example that is similar to a dedicated cable (i.e., a segment of a pipeline that connects a single customer to a larger pipeline). That example clarifies that such segments of a larger pipeline are identified assets.1 Because the IASB has stated that the IASB and the FASB have reached the same conclusions on how to define a lease,2 we believe that under IFRS 16, the last mile of a telecommunications network that connects a single customer to a larger network may be an identified asset. Telecom entities will need to be sensitive to this matter in both these and similar arrangements 'according to EY report.

Once the asset is identified, we will consider the following:

  1. Does the customer have the right to obtain all the economic benefits from use of the asset throughout the period of use?
  2. How and for what purpose the asset is used is predetermined?
  3. Did the customer design the asset in a way that predetermines how and for what purpose the asset will be used throughout the period of use?

If the answer to the above questions is yes then the contract will be considered a lease.

Separating the Lease Component

The right to use an underlying asset is a separate lease component if the following apply:

  1. The lessee can benefit from use of underlying asset either on its own or together with other resources that are readily available to the lessee.
  2. The underlying asset is neither highly dependent on, nor highly interrelated with the underlying assets in the contract. (IFRS16)

However, the standard includes a `practical expedient' for lessees only. This allows organisations to elect to not separate lease and non-lease components and instead account for both as if it were one lease component. The maintenance element is not a lease component, but because it is a component of a larger contract which contains a lease component the company may elect to apply the practical expedient and therefore treat the whole contract as one lease. 

This can also be explained in a situation when a communications company enters into a contract with a customer to provide telecom services. The transaction does not include the sale of a device. The company pays a third-party dealer a commission to connect the customer to its network. The customer signs an enforceable contract to receive telecom services for one year.

In this case the company identifies incremental contract acquisition costs and capitalize those costs that are recoverable. The communications company may use the practical expedient and expense contract acquisition costs when incurred if the amortization period would be one year or less. (The example is extracted from the PWC report).

Taxaccolega Chartered Certified Accountants who provide the accounting & taxation services in London and all over England & Wales and keep you fully up to date in IFRS 16 and be able to meet the relevant compliance. Please feel free to contact on info@taxaccolega.co.uk or call on 02081270728 for further help.

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