Revenue recognition project preliminary IFRS views Appendix N telecommunications

This industry-specific appendix should be read together with the publication titled Revenue recognition project preliminary IFRS views. The main body of the publication provides a summary of the revenue recognition model proposed in the Discussion Paper, highlights some issues for companies to consider in evaluating the merits of the Discussion Paper and discusses some of the expected changes to current IFRS. This appendix is provided as a means to highlight some of the more significant implications that the proposed revenue recognition model may have on the telecommunications industry. We encourage companies to read the topics carefully and consider the potential effects that the proposed model could have on their existing revenue recognition practices. The issues discussed in this appendix are intended to provoke thought and assist companies in analysing the potential implications, for their businesses, of the proposals contained in the Discussion Paper. The discussions within this publication do not represent final or formal views, as the elements of the Discussion Paper are subject to change on further deliberation by the Boards. The typical telecommunications (telecom) operators revenues are derived from the ongoing provision of fixed line (traditional) telephone, mobile (wireless) and internet services. The monthly fees charged for these services are generally fixed, although a portion may be based on usage. Revenue is recognised as services are provided. Prepaid mobile revenues are deferred and recognised in proportion to the number of minutes used. The model proposed in the Discussion Paper may significantly affect the amount and timing of revenue recognition for telecom operators, as discussed in further detail below. It is important to analyse the Discussion Paper in the context of the typical telecom business model, which is broadly founded on the fixed cost base of the network. Therefore, the business model is reliant on connecting and retaining customers on the network to generate contractual and non-contractual revenues through which the fixed cost base is recovered. Whilst such services may be provided in the context of a contract, referred to as postpaid, it is also very common for customer relationships to be non-contractual and pay-as-you-go, which is prepaid.

Telecom operators may make further customer acquisitions either directly or through third parties. As a result, complexities may arise when attempting to apply the proposed model under the Discussion Paper, in particular:

The connection of a customer on the

network comprises a range of activities, which may include the acquisition and retention of a customer relationship, the provision of activation services, the delivery of a handset and access to additional services. Moreover, telecoms operators contend that the activities on the acquisition of a customer (inception of the contract) are composed of net costs and revenues. For example, the proceeds from the handset may be effectively offset against other acquisition costs such as commissions and settled net with the distribution channel. The Discussion Paper does not appear to consider explicitly address such business models. A contract-based approach, and measurement of the related revenues, may be challenging to apply in an industry where a significant part of revenue is contingent and contracts are, in substance, only a subset of the overall economic relationship with the customer. For example, telecoms operators expect to receive contingent revenues during the initial contract term and expect revenues to continue subsequent to the expiry of the contract. It is not clear how such activities will be accommodated in the model proposed in the Discussion Paper.

The financial information currently provided by the operators separates the economic activities of customer acquisition and retention from revenues subsequent to acquisition. This information is relied upon by analysts and is the basis upon which the business is managed. Given the number of customers and volume of transactions, the systems that generate this information are highly complex. Therefore, without practical guidance, it may prove to be difficult to apply the proposed model in the telecoms sector and its application could give rise to substantial costs. It appears that transactions that the telecoms industry regards as economically identical could be reported differently, hence, changing financial information currently used in the industry. The discussion and the examples later in this appendix illustrate this.

Revenue recognition project preliminary IFRS views Appendix N telecommunications

Mobile revenues
Mobile contracts typically include multiple deliverables, such as handsets, voice services and data services. Handsets are provided customarily at a subsidised price significantly below the cost of the handset, or may even be provided at no cost to the customer. Voice and data services are often bundled. For example, telecom operators offer a set number of voice minutes or a set number of text messages for a flat monthly rate. In addition, telecom operators will charge customers for voice and data services in excess of the minimum amounts included in a bundle. Mobile contracts may also include add-on options, such as mobile internet or broadband, which a customer may cancel at any time (and, thus, are not bound to the term of the customer contract). Under current IFRS, telecom operators account for mobile contracts in accordance with IAS 18 and often refer to US GAAP guidance (EITF 0021) according to IAS 8. They have typically concluded that the handset and the mobile services may be accounted for as separate identifiable components. However, individual mobile services generally are treated as single deliverables and not separated because they are delivered at the same time. The activation fee is not considered a separate deliverable, as it does not have standalone value, and is simply considered an additional arrangement consideration to be allocated between the handset and the ongoing services. The handset (with activation) is delivered first, followed by the mobile service (which is provided over the contract period, generally one or two years). Because some amount of the arrangement consideration that may be allocated to the handset generally is contingent on the telecom operator providing the mobile service, the amount that may be allocated to the handset is limited to the cash received (i.e., the amount paid for the handset or activation fee, or combination of both) at the time of the handset delivery. It is unclear in the Discussion Paper which mobile contract components would be considered performance obligations under the proposed model. Performance obligations are not the same as the identifiable components derived as per IAS 18 and there is likely to be more performance obligations identified in an arrangement under the proposed model than under current IFRS. However, consistent with current practice, a telecom operator would only separately account for individual performance obligations to the extent they were delivered at different times (refer to the discussion on identifying performance obligations in the main body of this publication for further information). In addition, adoption of the proposed model may require information systems modifications to accommodate and track separate performance obligations. These modifications under the proposed model may be extensive if a significant number of additional separate performance obligations are identified. Under the proposed model, the handset may be considered a separate performance obligation as it is delivered at a different time than the ongoing service. Handset revenue will be recognised when control has transferred to the customer (possibly, when the customer takes physical possession of the handset). Alternatively, it may be more appropriate for a telecom operator to view a handset as a good used in the provision of a service. As discussed in the main body of this publication, the Boards propose a rebuttable presumption that an asset to be used in satisfying another performance obligation within the contract is not considered transferred to the customer until that other performance obligation is completed. If it is proven more appropriate to view the handset as a good used to provide a service, a telecom operator will not recognise revenue for the handset until its obligation to provide mobile services is satisfied. This may occur evenly over time, as the mobile service obligation is satisfied on a monthly basis, or when the mobile service is used, such as in a prepaid mobile arrangement. Regardless of which of these alternatives the Boards select, current revenue recognition practices for handsets are likely to be affected. If the handset and ongoing service are considered separate performance obligations, the allocation of revenue to each may differ, as compared to the current accounting policy applied by most operators. The contracts transaction price will be allocated based on the relative standalone selling price of the handset and other performance obligations. However, it is not clear what the standalone selling price of the handset is. For example, the standalone selling price of a handset may equal the amount for which the telecom operator sells the handset when customers replace a lost or damaged handset. Alternatively, the price could be based on a non-entity specific amount (e.g. the amount charged by another operator or distributor). However, it is likely not to be the discounted price offered to a new or renewing customer. Consequently, this may result in additional amounts being allocated to the handset and possibly earlier recognition of revenue than under current IFRS.

Revenue recognition project preliminary IFRS views Appendix N telecommunications

Furthermore, it appears that determining the standalone selling price of handsets might have to be done on an individual contract-by-contract basis due to the variations in prices offered to customers based on customer type (new or renewing), contract length, mobile plan and products included in the transaction (e.g. type of handset selected). If so, this could prove to be challenging, given the large volume of individual contracts entered into by telecom operators. The proposed model may also result in inconsistencies in the amount of revenue recognised for what is essentially a similar mobile plan. For example, telecom operators offer a variety of handsets with a wide range of standalone selling prices. A telecom operator may recognise less mobile service revenue for the same mobile plan when a customer purchases a higher-cost handset (such as a smartphone) versus a lower-cost handset (such as a basic handset without data and entertainment features). As mentioned previously, mobile contracts frequently include contingent amounts, such as add-on options or voice or data services in excess of the minimum amounts included in a bundle. Additionally, telecom operators expect many customers will extend their contracts for secondary terms that are not necessarily known at inception. The Discussion Paper does not address the measurement or timing of recognition of contingent consideration, so it is not clear how these situations will be addressed.

However, telecom operators may find it difficult to estimate contingent consideration on a contract-by-contract basis. The effects of changes in contract terms and conditions after contract inception also have not been considered under the proposed model. For example, telecom operators typically offer handset upgrades at discounted prices to existing customers at, or near the end of the contract period in order to induce the customer to renew the contract. Handset upgrades and contract renewals may occur before the end of the existing contract period. Under current IFRS, these upgrades generally are regarded as a contract modification, and sometimes involve loyalty schemes that are accounted for in accordance with IFRIC 13. The proposed model does not yet address how to account for contract renewals and modifications. However, if the telecom operator is obligated to provide a discounted phone in the future, that may represent a performance obligation to which some portion of the transaction price must be allocated under the proposed model.

Revenue recognition project preliminary IFRS views Appendix N telecommunications

Performance obligations: definition and attributing value to performance obligations

In the following examples, we have assumed that all performance obligations, other than the handset, transfer over the contract period. In addition, contingent amounts are recognised only when the service is provided and reasonable amounts can be determined for the standalone selling price of both handset and airtime services. 1) Same pay monthly 12-month airtime contract with different handsets (similar functionalities) A telecom operator is selling the following mobile plans: Offer 1: 12-month airtime contract for which the customer pays 20 per month (240 over the contract period) with a free handset. The only difference between the two offers is the design of the handset. The rebate allowed by the operator on both offers is the same (120). The second handset is of a newer and a better design but offers the same functionalities. There would be a similar fact pattern if the handset (Offer 2) had become outdated, and had been discounted more heavily than originally. The model proposed in the Discussion Paper would result in a different allocation of revenue to the services (120 in Offer 1 and 140 in Offer 2) although the rebate granted by the operator on the bundle is the same for both offers (120).
Table 1

The standalone price of the handset is

180 The standalone price of the airtime contract is 180 for the 12 month period (15 per month)

Offer 1
Handset Airtime Total

Base price
180 180 360

Weighted average discount

60 60 120

Allocated consideration
120 120 240

Offer 2: 12-month airtime contract for which the customer pays 20 per month (240 during the contract period) with a handset for which the customer pays 180 at inception.

Offer 2
Handset Airtime Total

Base price
360 180 540

Weighted average discount

80 40 120

Allocated consideration
280 140 420

The standalone price of the handset

is 360 The standalone price of the airtime contract is 180 for the 12-month period (15 per month)

Revenue recognition project preliminary IFRS views Appendix N telecommunications

2) A 12-month contract with different handsets (a simple handset and a smart phone) A telecom operator is selling the following offers: Offer 1: 12 month airtime contract for which the customer pays 20 per month (240 over the contract period) with a handset billed to the customer for 180 at inception date.

Offer 2: 12-month airtime contract for which the customer pays 20 per month (240 during the contract period) with a free smartphone.

The standalone price of the handset

is 360.

The standalone price of the airtime

The standalone price of the handset

is 360.

The standalone price of the airtime

contract is 180 for the 12 month period (15 per month)

contract is 180 for the 12-month period (15 per month). The operator expect that the customer will use smartphone functionalities that cost 360 in services for which there is no contractual commitment to browse the internet. The standalone price of those services is also 360.

Table 2.1

Offer 1
Handset Airtime Total

Base price
360 180 540

Weighted average discount

80 40 120

Allocated consideration
280 140 420

Offer 2
Handset Airtime Total initial contract revenue Additional expected services Total expected revenue

Base price
360 180 540 360 900

Weighted average discount

200 100 300

Allocated consideration
160 80 240 360

300

600

Revenue recognition project preliminary IFRS views Appendix N telecommunications

The rebate allowed by the operator on both offers is different because the handsets do not have the same characteristics. The operator is expecting more revenue from Offer 2 through additional services. Those additional services are listed in the contract, as selected by the customer, but the customer has the right to cancel the subscription for those additional services at any time during the contract. We see from the application that, on the assumption that the additional revenues
Table 2.2

cannot be taken into consideration, the whole rebate granted is allocated to the handset and the airtime. Therefore, the airtime revenue is different from Offer 1, for exactly the same service (140 against 80). If we assume another potential scenario in which we include additional services in the allocation, considering that they are part of the contract and can be included in the estimated transaction price, the allocation is much closer to Offer 1:

Offer 2
Handset Airtime Additional expected 1 services Total

Base price
360 180 360 900

Weighted average discount

120 60 120 300

Allocated consideration
240 120 240 600

1 These services are contingent and the Boards have yet to finalise how these revenues should be dealt with, i.e., should they be taken into account on Day 1, or not? This example assumes that they will be estimated on entering into the contract. The alternative would be to accounts for these services as additional contracts when requested by the user.

Activation fees and related costs

Telecom operators often charge new customers non-refundable up-front activation fees. These fees are not considered as a separately identifiable component under IAS 18 and, therefore, are not accounted for as separate deliverables. Under current IFRS, the operator considers the specific facts and circumstances to determine the appropriate accounting for non-refundable, up-front connection fees. When the connection transaction is bundled with the service arrangement in such a way that the commercial effect cannot be understood without reference to the two transactions as a whole, the connection fee revenue should be recognised over the expected term of the customer relationship under the arrangement that generated the connection. Up-front recognition of the non-refundable fee may be possible in some circumstances where a clearly demonstrable separate service exists, and this is provided at the inception of the contract The Discussion Paper does not comment on whether activation may or not be a separate performance obligation; or, whether activation fees received may or may not be considered a portion of the transaction price allocated to the mobile or fixed-line services underlying the contract performance obligations.

Revenue recognition project preliminary IFRS views Appendix N telecommunications

Equipment installation revenues

Telecom operators may provide businesses voice or data equipment installation, which involves installing cable and customer premise equipment (CPE), such as phone systems, modems and routers. The proposed model may significantly change the accounting for equipment installation revenues in several ways. Telecom operators will have to determine whether equipment installation is a good or a service; that is, whether control of the asset (e.g., the CPE) is transferred at a point in time or continuously over a period. Telecom operators will have to carefully consider the contract terms in order to determine whether CPE is transferred at the end of or throughout the construction period, factoring in the level of customisation, payment terms and the customers rights to work in progress. If an equipment installation contract is determined to be a good, then a telecom operator will not recognise revenue until the CPE is delivered and control has been transferred (generally, at the end of the construction period). On the other hand, if an equipment installation contract is determined to be a service, then a telecom operator will recognise revenue as control of the CPE is continuously transferred throughout the construction period. However, even if an equipment installation contract is determined to be a service, the revenue recognition pattern under the proposed model may differ compared with the percentage-of-completion method under IAS 11. Rather than recognising revenue based on the estimated extent of completion of the project, revenue will be recognised when control of the CPE is transferred. For example, if the CPE installation is completed in phases, then revenue may be recognised as each phase is completed. Telecom operators will have to consider all the facts and circumstances to determine the appropriate method to estimate the amount of assets transferred and to recognise revenue for equipment installation contracts that are considered service transactions.

Topics not yet addressed by the Boards

The proposed model does not address several areas. Examples of the more significant areas applicable to the telecom industry include the following: Right to use assets telecom operators may earn revenues from providing the right to use an asset, such as set-top boxes or indefeasible rights of use of fibre optic cable. The proposed model does not address how revenue will be recognised for the right to use an asset or whether lease accounting (from the lessors perspective) will be excluded from the scope of any final revenue recognition standard. Sales incentives sales incentives are common in the telecoms industry. Telecom operators often offer free products (mobile handsets), promotional offers (e.g., gift cards, free gifts, rebates) or volume discounts to customers. While the Discussion Paper indicates that sales incentives are likely to be accounted for as separate performance obligations, it does not conclude on how they will be measured. However, the Discussion Paper does suggest that determining whether a sales incentive is a performance obligation may be subject to the facts and circumstances of the contract. Breakage telecom operators may estimate breakage in determining revenue recognition for certain transactions. For example, recognition of prepaid calling card revenues typically incorporates breakage estimates. Revenues are deferred until the prepaid calling card minutes are used and breakage is recognised in income based on historical trends. The proposed model does not yet address breakage and how it may factor into the measurement of obligations.

Revenue recognition project preliminary IFRS views Appendix N telecommunications

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are typical within the telecom industry. For example, customers may dispute the rates charged by a telecom operator or the products and services provided. Under current IFRS, telecom operators generally recognise billing adjustments as a reduction of revenue. Under the proposed model, billing adjustments may factor into the measurement of the rights and obligations. The model does not yet address adjustments to the transaction price. Therefore, the accounting for billing adjustments is unclear. Right of returns mobile handsets are typically delivered with a right of return, which is accounted for in accordance with IAS 18. Under IAS 18, companies defer some revenue for future returns, if certain criteria are met. As more fully described in the main body of this publication, the Discussion Paper provides two alternative views on accounting for products sold with a right of return: account for the return right as a separate performance obligation or account for the return as a failed sale. Gross versus net presentation evaluating revenues for gross or net presentation is important in the telecom industry, particularly in indirect channel mobile arrangements (i.e., when mobile handsets and services are sold through a third party rather than directly through the mobile operator or when content is sold to the end customer by a content provider through the telecom operator). IFRS preparers often refer to EITF Issue No. 9919, Reporting Revenue Gross as a Principal versus Net as an Agent, in accordance with IAS 8, and will now refer to the improvement of IAS 18 which includes guidance on gross versus net reporting. The proposed model does not address presentation issues such as this. Please refer to our discussion of these areas in the main body of this publication for further information.

Billing adjustments billing adjustments

Final remarks
Our hope is that the issues discussed in this publication will prove thought provoking and will assist entities in analysing the potential implications of the proposals contained in the Discussion Paper for their businesses. However, the topics addressed in this appendix are not an exhaustive list of all the aspects of revenue recognition that the proposed model may affect. In addition, the issues discussed may change significantly based on any final standard promulgated by the Boards.

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