Accounting Standards
Revenue Recognition for Telecommunication Operators
The Research Committee of the Institute of Chartered
Accountants of India has issued an Exposure Draft – “Technical Guide on Revenue
Recognition for Telecommunication Operators” for comment. In this article, we
take a look at some of the contentious issues, and inconsistencies with
International Financial Reporting Standards (IFRS), particularly keeping in mind
that India will adopt IFRS from 2011-12 and onwards.
Whether revenue should be recognized on a gross basis or net
basis could be a very challenging issue for many telecom companies. For example,
a telecom operator may provide share price coverage via SMS as part of its
service offering. The stock exchange provides the data to the telecom operator.
Assuming revenue is Rs100 and payment to the stock exchange is Rs60, a question
arises as to whether the operator recognizes revenue of Rs100 and a cost of
Rs60, or merely recognizes Rs40 as its revenue. The answer to this question
depends on whether the operator acts as a principal or an agent in this
transaction. US GAAP provides guidance on this subject, which has been used in
the Technical Guide. As per the guidance, this decision is based on a cumulative
assessment of a number of factors such as: (a) whether the operator is the
primary obligor in the arrangement? (b) whether the operator has the ability to
control the selling price? (c) whether the operator changes the product or
performs part of the service? (d) who bears the credit risk? (e) whether the
product or service specification is determined by the operator?, etc. It may be
noted that the above criteria are not the same as those contained in IAS 18.
Hence, the answer arrived at based on the Technical Guide/US GAAP may not be the
same as the one arrived at under IFRS.
For most operators, interconnect charges represent the
largest single operating cost and second largest source of revenue. Mobile
operators enter into a number of interconnect agreements with other operators.
These agreements allow them to terminate a particular call or transit the
traffic on another operator’s network. This, essentially, uses network of
contracting parties to facilitate and provide the end-to-end connections
required by customers. The Technical Guide states that accounting of revenue on
gross basis may not be appropriate where net settlement and the legal right of
offset exists between operators. However, in the authors’ view, this is contrary
to industry practice. Industry practice is that interconnect revenues are booked
gross on the basis that the carriers are exposed to the gross risk of the
transaction. Interconnect agreements usually allow carriers to settle on a net
basis, which does not normally change the appropriateness of
recognizing transactions gross, even if periodic cash settlement may be made on
a net basis. For example, the operator may bear the gross credit risk for
non-payment and be obliged to make payments under interconnect arrangements,
irrespective of the level of reciprocal revenues due.
The term Indefeasible Rights of Use (IRU) is very common in
the telecom business. IRU means an exclusive, unrestricted, and indefeasible
right to use the relevant capacity (including equipment, fibres or capacity).
Under Indian GAAP, in many cases, these type of contracts may have been
accounted for as service contracts between the buyer and seller rather than
lease contracts. The technical guide requires evaluation of the IRU contract as
to whether it contains a lease arrangement based on AS-19. Unfortunately, AS-19
does not contain any guidance on the same. Under IFRS standards, this issue is
separately covered under IFRIC 4
Determining whether an
arrangement contains a lease.
Therefore, in the authors’ view, the technical guide with regard to this matter
can be practically implemented, if and only if an IFRIC 4 interpretation is
issued under Indian GAAP. Also it would be inappropriate to apply the
requirements of IFRIC 4 selectively to telecom companies. It may be noted that
IFRIC 4 has a wider application – for example, it would have impact on
outsourcing contracts, power purchase agreements, etc.
Multiple element contracts are pretty common in the case of
telecom business. For example, in the case of mobile operators, the package may
include hand set, talk time, SMS, ring tones, etc. The technical guide basically
requires the allocation of the consideration to the various components based on
the relative fair values of the components. It may be noted that currently, IFRS
does not have any detailed guidance on accounting for multiple element
contracts. However, IASB has recently issued a discussion paper (DP) on the
proposed new standard on revenue recognition – “Discussion
Paper – Preliminary views on Revenue Recognition in contract with customers“.
As per this DP, customer consideration is allocated to the vendor’s contractual
performance obligations on a relative standalone selling price basis, and
revenue is recognized as each performance obligation is satisfied. Where the
standalone selling price is not observable, an entity would estimate them. As
per the DP, suitable estimation methods include (but not limited to) (a)
expected cost plus margin (b) adjusted market assessment approach. Consequently
the Technical Guide and the proposed IFRS standard may result in significant
difference in accounting for multiple element contracts. Telecom operators that
may be required to follow the Technical Guide for Indian GAAP purposes and
subsequently IFRS, will have to unnecessarily undergo change in revenue
recognition accounting twice. This clearly appears unwarranted.
The Technical Guide prohibits recognition of revenue on a
component if the same is contingent upon delivery of additional items. This is
explained using the following example in the Technical Guide.
Example:
A customer purchases an annual contract, offering a free handset and 1,000
minutes (fair value is Rs. 1,500 per month) and 150 free texts (fair value is Rs.
300 per month), for a monthly fee of Rs. 1,500. The handset could be purchased
separately for Rs. 15,000. The allocation of revenue for the entire contract
period should be as follows:
|
|
|
Cash
|
Total
FV
|
Relative
FV
|
FV restricted by contingent
|
|
|
|
|
|
|
|
|
consideration
|
|
|
Handset
|
–
|
15,000
|
7,377
|
–
|
|
|
Airtime
contract
|
18,000
|
|
|
|
|
|
|
Talk time
|
|
18,000
|
8,852
|
15,000
|
|
|
Text
|
|
3,600
|
1,771
|
3,000
|
|
|
Total
|
18,000
|
36,600
|
18,000
|
18,000
|
|
The relative fair value of the equipment is Rs. 7,377. However, the recognition of this amount should be limited to the amount which is not contingent upon the delivery of additional items (i.e. airtime contract). As a result, the relative fair value allocable to the equipment is reduced to Rs. nil, being the cash consideration, and the difference reallocated to the elements within the airtime contract. It may be noted that under IFRS, there is no such restriction and it is possible to recognize revenue on the handset.
In another example, the Technical Guide prohibits recognition of revenue on hand set in certain circumstances. For example, consider a customer enters into a 12 month tariff plan priced at Rs 2400/- and includes 200 minutes of talk time per month and free hand set worth Rs 2000/-. The Technical Guide prohibits recognition of any revenue on the delivery of the handset, since it is provided free and requires recognition of revenue of Rs 200/-per month for the talk time. In this example, it is unclear from the Technical Guide as to how the accounting is done, if the company would have stated that Rs 2,400/- is received for both the talk time and the handset. Will the accounting change? Under IFRS, it would be possible to recognize revenue on handset, even if the company claims that the same is provided free of cost. This is because under IFRS, the entire consideration would be allocated to different components – in this example, it would be allocated to the handset and the talk time irrespective of the operators’ claim that some of the components are provided free of cost (basically there is no free lunch).
The Technical Guide is more based on US GAAP and may provide results that are different from those under existing or proposed IFRS standards.
Given that India is adopting IFRS, and US itself is looking at IFRS seriously, it does not make any sense to base the Technical Guide on US GAAP. It is recommended that standard setters start a dialogue with the IFRS standard setters and influence the IFRS exposure drafts, rather than rock the boat. It is also inappropriate to have any guidance that is inconsistent with IFRS, since that may require Indian entities to change revenue recognition accounting twice in a short span of time, ie, once to comply with Indian GAAP and in 2011-12 when adopting IFRS.
