The impact of

IFRS 16 on
telecommunications
accounting for
long-term capacity
arrangements
 2 PwC The impact of IFRS 16 on telecommunications accounting for long-term capacity arrangements

Background

Telecommunications entities have been grappling with the

accounting for long-term capacity arrangements ever since
International Financial Reporting Standards came into
widespread use, and a new standard issued in 2016 (IFRS
16) will soon add another layer of complexity. Starting in
2019, entities will need to apply IFRS 16 accounting
requirements for leases. This new standard is prompting
many operators to reconsider, given the guidance the
standard provides, whether their capacity arrangements
contain leases.
This report applies IFRS 16 to a variety of common capacity
arrangements to see if they contain leases, and it explores
these arrangements’ impact on accounting.
 3 PwC The impact of IFRS 16 on telecommunications accounting for long-term capacity arrangements

Determining whether an
arrangement contains a lease
IFRS 16 defines a lease as a contract, or part of a contract, An identified asset can be a physically distinct portion of a
that conveys the right to control use of an identified asset larger asset. A capacity portion — a portion of a larger asset
for a period of time in exchange for consideration. At first that is not physically distinct — is not considered an
sight, the definition looks straightforward. But in practice, identified asset unless it represents substantially all of the
it can be difficult to assess whether a contract conveys the capacity of the entire asset.
right to use an asset or is instead a contract for a service
that is provided using that asset. Breaking down the
definition can help entities determine their
accounting obligations.

What is an identified asset?

An asset can be identified either explicitly or implicitly. If
identification is explicit, the asset is specified in the
contract (for example, by a serial number or a similar
identification marking); if implicit, the specific asset itself
is not mentioned in the contract but the supplier can fulfil
the contract only by using a particular asset. In both cases
there might be an identified asset.
There is no identified asset if the supplier has a substantive
right to substitute the asset. Substitution rights are
considered substantive when the supplier has the practical
ability to substitute an alternative asset and would also
benefit economically from substitution.
The term ‘benefit’ is interpreted broadly. For example, the
fact that the supplier could deploy a pool of assets more
efficiently by substituting the leased asset from time to
time might create a sufficient benefit, as long as there are
no significant costs associated with the substitution. It is
important to note that costs are considered ‘significant’ if
they exceed the economic benefits of the substitution,
regardless of whether the costs are low or not material to
the supplying entity as a whole. Significant costs could
occur, in particular, if the underlying asset is customized
for the customer.
A right to substitute an asset if it is not operating properly,
or if a technical update is required, is not regarded as
substantive, which means the asset could still be
considered identified. The same is true for a supplier’s
right or obligation to substitute an underlying asset for any
reason on or after a particular date or on the occurrence of
a specified event.
 4 PwC The impact of IFRS 16 on telecommunications accounting for long-term capacity arrangements

When does the customer have the right to If both parties have decision-making rights, an entity would
control the use of an identified asset? consider the rights that are most relevant to changing how
and for what purpose the asset is used. However, there are
A contract conveys the right to control the use of an several rights that are not taken into account:
identified asset if the customer has both the right to obtain
substantially all of the economic benefits from its use and • Protective rights: In many cases, a supplier might limit
the right to direct the use for a period of time. the customer’s use of an asset in order to protect
personnel or ensure compliance with relevant laws and
Economic benefits can be obtained directly or indirectly regulations. These protective rights do not affect the
(for example, by using, holding or subleasing the asset). assessment of which party has the right to direct the use
Benefits include the primary output and any by-products of the identified asset.
(including potential cash flows derived from these items),
as well as payments from third parties that relate to the use • Maintaining/operating the asset: Being able to make
of the identified asset. However, economic benefits relating decisions about maintaining and operating an asset does
solely to the ownership of the asset (such as some tax not grant the right to direct the use of the asset. These
credits or reliefs) are ignored. maintenance and operations rights are only taken into
account if decisions about how and for what purpose the
When assessing who directs use of the asset, the key asset is used are predetermined (see below).
question is which party (customer or supplier) has the
right to direct how and for what purpose the identified • Decisions made before the period of use: These
asset is used throughout the period of use. sorts of decisions are not taken into account unless they
are made in the context of the design of the asset by a
IFRS 16 gives several examples of relevant customer (see below).
decision-making rights:
In some scenarios, decisions about how and for what
• Right to change what type of output is produced. purpose the underlying asset is used are predetermined
• Right to change when the output is produced. before the inception of the lease. If this is the case, the
customer has the right to direct the use of an asset
• Right to change where the output is produced. if it either:
• Right to change how much of the output is produced. • has the right to operate the identified asset throughout
the period of use without the supplier having the right to
change those operating instructions, or
• has designed the identified asset (or specific aspects
of the asset) in a way that predetermines how and for
what purpose the asset will be used throughout the
period of use.
Sometimes, an identified asset is incidental to a service but
has no specific use to the customer by itself. This subject is
considered further in our publication,
Accounting for customer premises equipment
under IFRS 15 and IFRS 16.
 5 PwC The impact of IFRS 16 on telecommunications accounting for long-term capacity arrangements

Illustrative examples

1. Original investment via consortium Accounting analysis

agreement Although the focus of this publication is on whether
A telecommunications operator (OrigCo) enters into a arrangements contain leases, this first example considers a
consortium agreement with three other parties for the different, but also common, issue, which is foundational for
construction of a subsea cable system between Australia some of the lease examples that follow.
and New Zealand. The consortium agreement does not The consortium members, including OrigCo, have entered
involve the creation of any new legal entity, and the into an agreement that gives them joint control over a
consortium members hold joint legal title over the assets. collection of assets that together constitute a subsea cable
Under the terms of the agreement, each party is system. Decisions regarding the development and operation
responsible for 25% of the capital and operating costs of of the system require the unanimous agreement of all
the cable system for the entirety of its life. The agreement consortium members. Accordingly, this represents a joint
stipulates which elements of development each party is arrangement within the scope of IFRS 11.
responsible for delivering (e.g. cable laying or landing The arrangement does not involve creation of a separate
stations), with the 25% share of costs being subject to a legal entity, so it is treated as a joint operation. OrigCo will
true-up process. Decisions regarding the development and therefore account for its 25% share of the consortium’s
operation of the system require the unanimous agreement assets, liabilities, revenue and expenses.
of all consortium members.
2. Capacity purchased from consortium
Each party is entitled to 25% of the planned capacity of the
member (with capacity guarantee)
system, defined in terms of gigabits per second (Gbps). As
planned upgrades to the transmission equipment are Another telecommunications operator (ShareCo) enters
made over the life of the system, each consortium member into an agreement with OrigCo for the use of half of the
will continue to be entitled to 25% of the increased capacity that OrigCo owns through its membership in the
system capacity. As Wave Division Multiplexing (WDM) consortium described in example 1. The agreement between
equipment is installed, each consortium member’s capacity ShareCo and OrigCo has a fixed term of 20 years, which is
share will be redefined in terms of wavelengths rather the expected service life of the cable system.
than Gbps.
Under the terms of the agreement, ShareCo will be
There are no restrictions on how the consortium members responsible for reimbursing OrigCo for 50% of the
use or resell the capacity on the system. operating cost payments it makes to the consortium.
The use of WDM equipment on the system means that Decisions regarding the development and operation of the
none of the consortium members controls the use of any system continue to be made by the original consortium
individual fibre on the subsea cable, and the WDM members, including OrigCo, and require the unanimous
transceivers also are a shared asset supporting the agreement of all members.
transmission of data for all consortium members.
ShareCo is entitled to 12.5% of the planned capacity of the
Consortium members’ traffic is delivered to the cable
system (half of OrigCo’s consortium rights). At the outset of
system using multiple industry-standard transmission
the agreement, ShareCo’s capacity is defined in Gbps, but
technologies (i.e., not necessarily at the wavelength over
this will be redefined in terms of wavelengths as WDM
which they have contractual rights). One of a number of
equipment is installed.
transponders that form part of the WDM terminal
multiplexer converts the incoming signals to the There are no restrictions on how ShareCo may use or
separate wavelengths used in the WDM system. resell its capacity.
Although the contract provides for penalties if service levels
fall below specified limits, there is no provision for OrigCo
to provide any resilience (alternative routing).
 6 PwC The impact of IFRS 16 on telecommunications accounting for long-term capacity arrangements

Accounting analysis Accounting analysis

In contrast to example 1, ShareCo does not share control Unlike the previous examples, there is no consideration in
of the system, so is not a party to the joint operation. this case of whether the entities have entered into a joint
ShareCo’s obligations are to make payments to OrigCo as a arrangement, because there is no sharing of decision
result of their agreement, and not to share in the assets or making regarding the business or assets. Instead, the
liabilities of the joint operation. The question is whether analysis is only concerned with whether the arrangement
the arrangement gives ShareCo rights to control the use of contains a lease.
any specific assets, which would indicate the existence
A contract contains a lease where it conveys the right to
of a lease.
control the use of an identified asset for a period of time.
ShareCo does not obtain the right to use any identified In this case, DarkCo obtains the right to use a distinct fibre
network assets. Instead, ShareCo is entitled to 12.5% of the for a period of 20 years. However, IFRS 16 requires a
planned capacity of the entire system, which represents more detailed analysis, including consideration of the
50% of OrigCo’s consortium rights. Clearly, ShareCo’s following questions:
capacity portion does not represent substantially all of the
• Does NatCo have a substantive right to substitute for
capacity of the network or any component part. So, the
another fibre such that there is no ‘identified’ asset
arrangement does not contain a lease.
according to IFRS 16? The answer is no. For a
From the outset of the agreement, when ShareCo’s capacity substitution right to be substantive, that right must be
is defined in Gbps, the arrangement represents delivery of practicable throughout the term of the arrangement, and
a service from OrigCo and not a lease (see also: example 5). NatCo must benefit economically from its exercise. In this
As WDM equipment is installed, and ShareCo’s capacity case, NatCo has a substitution right only for repair,
share is redefined in terms of wavelengths, it might be maintenance or malfunction, and must pay compensation
concluded that the substance of the arrangement changes. if it exercises that right. IFRS 16 is clear that a
The treatment of rights to use specific wavelengths is substitution right that exists only in the case of repair,
considered further in example 4. maintenance or upgrade does not preclude the
existence of a lease.
3. IRU – Dark fibre lease
• Does DarkCo have the right to obtain substantially all of
A telecommunications operator (DarkCo) enters into an the economic benefits from use of the fibre? Yes, DarkCo
indefeasible rights of use (IRU) contract with NatCo (the has exclusive use of the fibre, and there are no
incumbent telecommunications operator) for a dark fibre restrictions on how it may use or resell the capacity.
route between two cities. The agreement is for a term of 20
years, which is the expected service life of the cable. • Does DarkCo have the right to direct the use of the fibre?
IFRS 16 focuses on the ability to make decisions about
The arrangement specifies exclusive use of a distinct fibre how and for what purpose the fibre is used. So yes, it is
within the NatCo fibre cable, and DarkCo is responsible for clear from the fact pattern that DarkCo does have
the installation of transmission equipment in NatCo’s that ability.
buildings in order to light the fibre. NatCo has the right to
swap DarkCo over to an alternative fibre, but only for Based on this analysis, the arrangement does contain a
reasons of repair, maintenance or malfunction, in which lease. The fact pattern resembles Illustrative Example
case it must compensate DarkCo for financial loss. 3A in IFRS 16, and the solution is the same.

In addition to a single up-front payment, the contract Although it’s irrelevant for DarkCo, NatCo must determine
provides for NatCo to charge DarkCo for a share of whether the lease is a finance lease or an operating lease. In
maintenance costs and for space, power and cooling this case, the arrangement is for 20 years, which is the
within the NatCo buildings. expected service life of the cable in which DarkCo’s fibre is
encased. Determining whether a lease is a finance lease or
DarkCo is responsible for the installation and maintenance an operating lease requires the exercise of judgment, but
of its transmission equipment and is free to upgrade that where the lease term is for a major part of the economic life
equipment during the life of the contract. of the leased asset, this normally indicates that the lease is a
There are no restrictions on how DarkCo may use or finance lease. Accordingly, the arrangement between NatCo
resell its capacity. and DarkCo likely contains a finance lease.
 7 PwC The impact of IFRS 16 on telecommunications accounting for long-term capacity arrangements

4. IRU – Wavelength The wavelength of a beam of light, like its frequency, is a

property of that light and not a physical attribute. It is
A telecommunications operator (WaveCo) enters into an therefore inappropriate to describe a wavelength as if it
agreement with OrigCo for the use of specified wavelengths were a physical asset. An intangible asset is defined in
that OrigCo controls through its membership in the International Accounting Standard 38 as an identifiable
consortium described in example 1. The agreement nonmonetary asset without physical substance. A right to
between WaveCo and OrigCo has a fixed term of 20 years, use specific wavelengths could therefore meet the definition
which is the expected service life of the cable system. of an intangible asset, which is how spectrum licences are
Under the terms of the agreement, WaveCo will be consistently treated by mobile operators.
responsible for reimbursing OrigCo for a fixed percentage A lessee may, but is not required to, apply IFRS 16 to leases
of the operating cost payments it makes to the consortium. of intangible assets (other than in a few specified cases).
Decisions regarding the development and operation of the WaveCo might, therefore, take this approach and treat the
system continue to be made by the original consortium arrangement as containing a lease of an intangible asset.
members and require the unanimous agreement of all If WaveCo does not apply IFRS 16, it must determine
the original members. WaveCo is not a member of the whether the arrangement includes the acquisition of a
consortium, but OrigCo must consult with WaveCo licence (intangible asset) or constitutes solely a service from
regarding any decisions that could affect service continuity OrigCo. Where WaveCo attaches its own optronics and is
and quality (such as an equipment upgrade that would responsible for transmission, the former might be
interrupt service for WaveCo), and will be subject to appropriate, but if OrigCo is responsible for transmission,
service credits if service levels fall below the minimum the latter is more likely to reflect the substance of the
standards set out in the contract. arrangement. The specific fact pattern presented here is
WaveCo is entitled to transmit traffic over a specific less clear-cut. In practice today, it is more common to see
wavelength within the WDM system, which represents 5% these arrangements treated as a service.
of the planned capacity of the system (20% of OrigCo’s OrigCo, as the supplier, would be expected to consider
consortium rights). The contract prevents OrigCo from how many distinct performance obligations exist in its
allowing any other party to utilise this specific wavelength. arrangement with WaveCo, and whether one of those
Although it might be technically possible for OrigCo to comprises a licence to use a specific wavelength. Consistent
change the wavelengths used by WaveCo according to their with the previous paragraph, it is more common today to
agreement (through a change in port on the WDM see the entire arrangement treated as a single service.
transceivers) or the fibre on which WaveCo’s traffic is Therefore, OrigCo would approach the arrangement from
carried, any such change would cause interruption to the perspective of IFRS 15, which is not the subject of
WaveCo’s service, so this is not anticipated unless this publication.
significant equipment upgrades or replacement is required.
5. IRU – Capacity
There are no restrictions on how WaveCo may use or resell
All facts in this example are the same as in example 4,
its capacity.
except that WaveCo’s capacity is defined in Gbps and may
The contract provides for penalties if service levels fall be carried on any wavelength at the discretion of OrigCo.
below specified limits, but there is no provision for
Accounting analysis
OrigCo to provide any resilience (alternative routing).
This fact pattern is similar to Illustrative Example 3B in
Accounting analysis
IFRS 16. As in that example, and in contrast to example 3,
Similar to the analysis of ShareCo’s rights in example 2, OrigCo makes all decisions about the transmission of
WaveCo does not have access to rights that give it joint WaveCo’s data, which requires the use of only a portion of
control over the cable system, so the agreement does not the capacity of the cable. The capacity portion that will be
constitute a joint operation. provided to WaveCo is not physically distinct from the
remaining capacity of the cable and does not represent
Applying the principles set out in example 3, it is also clear
substantially all of the capacity of the cable. Consequently,
that WaveCo does not have the right to control the use of
WaveCo does not have the right to use an identified asset.
any identified fibre or other physical asset. Nor does its
Equally, there is no right to use a specific wavelength and so
capacity portion represent substantially all of the network
the considerations from example 4 are not relevant. This
capacity or any component part. It does, however, have the
arrangement represents the delivery of a service from
right to control the use of specific wavelengths. Would such
OrigCo to WaveCo from the perspective of IFRS 15, which is
an arrangement fall within IFRS 16’s scope?
not the subject of this publication.
To have a deeper conversation about how the
proposed changes to accounting for revenue
may affect your business, please contact:

EMEA Asia Pacific

Christoph Gruss Fernand Izeboud George Cheng
Frankfurt The Hague Hong Kong
christoph.gruss@de.pwc.com fernand.izeboud@nl.pwc.com george.ly.cheng@hk.pwc.com
+49 699 585 3415 + 31 0 70 342 655 + 852 2289 2602

Thomas Tandetzki Fabio Chierico Akhlesh Chowla

Düsseldorf Milan India
thomas.tandetzki@de.pwc.com fabio.chierico@it.pwc.com akhlesh.chowla@in.pwc.com
+49 211 981 1105 +39 34 0097 6120 + 91 22 6669 1216

Paul Barkus Gabor Balazs Rosalie Wilkie

London Budapest Australia
paul.barkus@pwc.com gabor.balazs@hu.pwc.com rosalie.wilkie@au.pwc.com
+44 20 7213 5514 +36 14 61 9534 +61 2 8266 8381

Peter Hogarth Vanessa Gonzalez Prieto

London Madrid Americas
peter.hogarth@pwc.com vanesa.gonzalez.prieto Shaun Goldfarb
+44 20 7213 1654 @es.pwc.com Chicago
+34 915 684 826 shaun.m.goldfarb@pwc.com
Mark King
+1 (312) 298 2778
London Radomil Maslak
mark.king@pwc.com Warsaw John Simcoe
+ 44 207 804 687 radomil.maslak@pl.pwc.com Toronto
+48 22 746 4223 john.b.simcoe@pwc.com
Richard Veysey
+1 (416) 727 5953
London Helen Wise
richard.j.veysey@pwc.com Johannesburg Geoff Leverton
+44 20 7212 1060 helen.wise@za.pwc.com Toronto
+27 11 797 5293 geoff.m.leverton@pwc.com
Matthieu Moussy
+1 (416) 815 053
Paris
matthieu.moussy@fr.pwc.com
+33 15 657 8630

About TIAG
The PwC Telecom Industry Accounting Group provides a forum for discussion and develops, inconjunction with the
industry, solutions to emerging industry accounting issues.

About PwC
At PwC, our purpose is to build trust in society and solve important problems. We’re a network of firms in 158 countries with more than 236,000
people who are committed to delivering quality in assurance, advisory and tax services. Find out more and tell us what matters to you by visiting
us at http://www.pwc.com/
This content is for general information purposes only and should not be used as a substitute for consultation with professional advisors.
© 2018 PwC. All rights reserved. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC
network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details.