Telecom Accounting Treatment Focus - Ey India

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In this issue, EY India is focusing on the key industry topics and the effect it has on operators' financial statements under International Financial Accounting Standards (IFRS). This analysis will help CFOs and Senior Accounting Management to understand the appropriate telecom accounting treatment. Download PDF now.

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EY’s Spotlight on T elec ommunic ations Ac c oun ting Welcome to the frst edition of EY’s Spotlight on T elecommunications Accounting. With this new publication we will address current industry practices and how they impact operators’ fnancial reporting. Your local EY partner and I are happy to discuss any of these issues in greater detail with you. Holger Forst Global Telecommunications Assurance Leader EY’s Spotlight on Telecommunications Accounting is a bimonthly publication that addresses key industry topics and their impact on the fnancial statements of operators reporting under International Financial Accounting Standards IFRS. These brief summaries provide chief fnancial offcers and senior accounting management with information on current topics that may impact fnancial statements and key performance indicators and help them to determine the appropriate accounting treatment. Issue 1/2015 Considerations under IFRS

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2 EY’s Spotlight on T elecommunications Accounting Decommissioning liabilities With the number of commercial long-term evolution L TE networks worldwide now past the 300 mark industry players are already turning their attention to the potential for LTE — Advanced Technology also known as LTE Release 10 which offers three times the spectral effciency of L TE. According to the Global Mobile Suppliers Association GSA 318 operators have launched LTE networks as of July 2014 while 69 operators are deploying LTE — Advanced technologies. LTE technology-based infrastructure revenue will continue to grow over the coming years and is expected to reach US20.5 billion in 2018. In this light the move towards more sophisticated mobile network technologies involves the deployment of new equipment and the retirement of old infrastructure. As a result telecoms operators will have to identify redundant sites that they expect to decommission remove the equipment terminate the underlying leases and settle the obligation related to the constructed assets as a consequence of having used the site. In the construction of wireless and fxed line networks telecoms operators often build on leased land. The terms and conditions of lease agreements usually require operators to dismantle and remove communications facilities e.g. radios back-up batteries antennas transmission lines and air conditioning equipment and return the site to the landlord in the same condition that existed prior to entering into the lease agreement. If there are no obligations specifed by law or contractual agreements management will also need to consider constructive obligations arising from past practice or public statements. For example operators may have an obligation in connection with decommissioning a coastal landing station connected to undersea cables.

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EY’s Spotlight on T elecommunications Accounting 3 These obligations are referred as decommissioning liabilities and are recognized and measured in accordance with IAS 37 Provisions Contingent Liabilities and Contingent Assets. Accounting for decommissioning liabilities is often complex and requires the exercise of signifcant judgment and the use of estimates and assumptions. Key questions related to the application of IAS 37 include: a how should telecoms operators account for dismantling and removal costs and b how should changes in the estimated obligation of an existing decommissioning liability be refected Under IAS 37 decommissioning liabilities are recognised at the time the asset is constructed because this is when the obligation to dismantle is created. The future site restoration costs are estimated and discounted to their present value to refect the best estimate of the expenditures required to settle the present obligation as at the reporting date. The estimate should include attributable direct costs such as labour site cleaning equipment uninstallation and demolition. Site restoration costs must be capitalised as part of the cost of the asset and depreciated over that asset’s useful life in accordance with IAS 16 Property Plant and Equipment. The following inputs should be considered in the initial estimate of decommissioning liabilities: • The contractual period of the lease although it may be longer or shorter in case of renewal options or early termination options. • The discount rate shall be a pre-tax rate that refects current market assessment of the time value of money and the risks specifc to the liability. Risks can be refected either by an increase in the estimated expenditures or a decrease in the discount rate. The starting point for this rate is a government bond rate of a similar currency and term as the obligation. • The infation rate which will be refected either by using current prices discounted at a real discount rate or using expected future prices discounted at a nominal discount rate. At the end of each reporting period the amount of the decommissioning liability is reviewed and adjusted to refect the unwinding of the discount and changes in the estimated timing or amount of outfows required to settle the obligation. IFRIC 1 Changes in Existing Decommissioning Restoration and Similar Liabilities contains guidance on how to account for the effect of these changes. Changes in the estimated timing or amount of cash outfows may result from various factors such as: • Changes in observable inputs from the market e.g. increase in labour or material costs • Changes due to development of new technologies and/or practices that may make the decommissioning process more effcient • Changes in legal or regulatory requirements that could impose new requirements and costs • Changes in terms and conditions of the lease agreement e.g. termination of a lease agreement • Macro-economic variables such as infation rates or government bond rates If the asset is measured at cost which is often the case changes in the estimate of the decommissioning liabilities are added to or deducted from the carrying value of the related asset. However the periodic unwinding of the discount is recognised in proft and loss as a fnance cost as it occurs. Any amount deducted from the cost shall not exceed the asset’s carrying amount. If a decrease in the liability exceeds the carrying value of the asset the excess shall be recognised immediately in proft or loss. If the adjustment results in an addition to the cost of an asset the entity shall consider whether this gives rise to an indication of impairment of the asset. The adjusted carrying amount of the asset is depreciated prospectively over its remaining useful life. Therefore once the related asset has reached the end of its useful life all subsequent changes in the liability shall be recognised in proft or loss as they occur .

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4 EY’s Spotlight on T elecommunications Accounting T ower sale and leaseback transactions Tower sale and leaseback transactions involve the sale of towers by a telecoms operator to an independent tower company T owerco and the immediate leaseback of space on the towers on which the operator’s active telecoms equipment are located. The transaction landscape saw a number of global deals struck as operators looked to divest of non-core assets and tower companies took advantage of favourable borrowing conditions. These transactions also allow operators to increase liquidity and reduce ongoing capital expenditure. It also results in industry-wide cost effciencies and helps in the growth of telecoms services by avoiding duplication of infrastructure. These benefts have led to sale and leaseback transactions becoming increasingly popular with leading operators. For instance in 2015 tower companies in Africa will own around 32 of all wireless towers compared to less than 5 in 2010. Accounting for such transactions is often complex and requires the exercise of signifcant judgement and the use of estimates and assumptions. Following are some of the key accounting considerations and challenges relating to such transactions: • When should towers be classifed as held for sale and how they should be measured • Whether the tower infrastructure being sold is a cash generating unit CGU or an operation within a CGU. In some cases operators might have acquired the towers as part of an earlier business combination so the question arises whether goodwill acquired in that business combination needs to be included in the carrying value of the CGU comprising towers

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EY’s Spotlight on T elecommunications Accounting 5 • Accurately recognising the gain realised on the portion of the tower sold and the portion leasedback • Determining the type of lease involved i.e. whether the leaseback is under a fnance or an operating lease arrangement IFRS 5 Non-current Assets Held for Sale and Discontinued Operations addresses the accounting for assets held for sale and the presentation and disclosure of discontinued operations. IFRS 5 requires a non-current asset or disposal group to be classifed as held for sale if its carrying amount will be recovered principally through a sale transaction rather than through continuing use. For an asset or disposal group to be classifed as held for sale: • It must be available for immediate sale in its present condition subject only to terms that are usual and customary for sales of such assets or disposal groups. • Its sale must be highly probable. Non-current assets that are to be abandoned shall not be classifed as held for sale as their carrying amount will be recovered principally through continuing use. IFRS 5 requires that non-current assets classifed as held for sale be measured at the lower of carrying amount and fair value less costs to sell with depreciation on them ceasing. They must be presented separately on the face of the statement of fnancial position. When in addition to the criteria as held for sale also the criteria for classifcation as discontinued operations are met the results from discontinued operations shall be presented separately on the face of the statement of comprehensive income. A disposal group includes goodwill acquired in a business combination if the disposal group is a CGU to which goodwill has been allocated as per IAS 36 Impairment of Assets. Regular tower sale and leaseback transactions usually lead to classifcation of the towers as assets held for sale whereas the classifcation as a separate CGU is rare. Tower sale and leaseback transactions usually fall under the scope of IAS 17 Leases as the arrangement provides a “right to use a specifc tower .” Accordingly the next step is to evaluate whether the lease is a fnance lease or an operating lease and it depends on the substance of the transaction rather than the form of the contract. Examples of situations which either individually or in combination would normally lead to a lease being classifed as a fnance lease are: • The lease transfers ownership of the tower to the lessee by the end of the lease term • The lessee has an option to purchase the tower at a price that is expected to be suffciently lower than the fair value to be reasonably certain at the inception of the lease that the option will be exercised • The lease term is for the major part of the economic life of the tower even if title is not transferred • At the inception of the lease the present value of the minimum lease payments amount to at least substantially all of the fair value of the leased tower • The leased tower is of such a specialised nature that only the lessee can use it without major modifcations • If the lessee can cancel the lease the lessor’s losses associated with the cancellation are borne by the lessee • Gains or losses from the fuctuation in the fair value of the residual accrue to the lessee for example in the form of a rent rebate equaling most of the sales proceeds at the end of the lease • The lessee has the ability to continue the lease for a secondary period at a rent that is substantially lower than market rent When a lease includes land and building elements an entity should separately assess the classifcation of each element as a fnance or an operating lease. Under IAS 17 if a sale and leaseback transaction results in a fnance lease any excess of sales proceeds over the carrying amount shall not be immediately recognised as income by a seller-lessee. Instead it shall be deferred and amortised over the lease term. If a sale and leaseback transaction results in an operating lease and it is clear that the sales price is at fair value any proft or loss shall be recognised immediately. If the sale

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6 EY’s Spotlight on T elecommunications Accounting price is below fair value any proft or loss shall be recognised immediately except that if the loss is compensated for by future lease payments at below market price it shall be deferred and amortised in proportion to the lease payments over the period for which the asset is expected to be used. If the sale price is above fair value the excess over fair value shall be deferred and amortised over the period for which the asset is expected to be used. Tower lease agreements often involve various elements including: a the right to use space on the tower b a portion of the land on which the tower is located and c tower operation and maintenance services. The arrangement is sometimes referred to as a multiple-element arrangement. IAS 17 requires separate recognition of a lease that is embedded or contained within a multiple-element arrangement because it applies to agreements that transfer the right to use assets even though substantial services by the lessor may be called for in connection with the operation or maintenance of such assets. In addition the defnition of minimum lease payments under IAS 17 clarifes that such payments exclude costs for services. Therefore operators will need to split the lease charges and service charges on the basis of the relative fair values of the different elements. In May 2013 the IASB and FASB issued a joint lease accounting proposal which they are currently re-deliberating on key aspects. We will present the impact of the new lease standard on operators in a separate publication once the standard is issued.

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EY’s Spotlight on T elecommunications Accounting 7 Contact details Holger Forst Global Telecommunications Assurance Leader holger .forstde.ey.com Dennis Deutmeyer Global Telecommunications IFRS Leader dennis.deutmeyerey.com Aurélie Frost Global Telecommunications Assurance Sector Resident aurelie.frostlu.ey.com

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About EY EY is a global leader in assurance tax transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over . We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing we play a critical role in building a better working world for our people for our clients and for our communities. EY refers to the global organization and may refer to one or more of the member firms of Ernst Young Global Limited each of which is a separate legal entity. Ernst Young Global Limited a UK company limited by guarantee does not provide services to clients. For more information about our organization please visit ey.com. How EY’s Global T elecommunications Center can help your business Telecommunications operators are facing a rapidly transforming business model. Competition from technology companies is creating challenges around customer ownership. Service innovation pricing pressures and network capacity are intensifying scrutiny on the return on investments. Additionally regulatory pressures and shareholder expectations require agility and cost efficiency. If you are facing these challenges we can provide a sector-based perspective on addressing your assurance advisory transaction and tax needs. Our Global Telecommunications Center is a virtual hub that brings together people cultures and leading ideas from across the world. Whatever your need we can help you improve the performance of your business. © 2015 EYGM Limited. All Rights Reserved. EYG no. EF0149 CSG/GSC2015/1564051 ED None In line with EY’s commitment to minimize its impact on the environment this document has been printed on paper with a high recycled content. This material has been prepared for general informational purposes only and is not intended to be relied upon as accounting tax or other professional advice. Please refer to your advisors for specific advice. ey.com/telecommunications EY | Assurance | Tax | Transactions | Advisory

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