Dipthi: Welcome to the second episode of the Telco Talks podcast series focusing on topical issues in the telecommunications industry. I’m Dipthi Govind, a technical accounting manager in the PwC South African practice and I will be your host. Our aim is to keep you up to date with key accounting and business issues in the telecommunications industry.
In this episode, we are going to be discussing an important consideration in lease arrangements, being the unit of account in terms of IFRS 16 Leases.
Joining me in this episode is Thamesha Chetty, a technical accounting manager specialising in the telecommunications industry in our PwC South African practice. Welcome to the podcast series Thamesha.
Thamesha: Hi Dipthi, thank you. I’m very excited to be part of the podcast series.
Dipthi: Perhaps to kick-off, can you explain when assessing leases, why the unit of account is important.
In our last episode, it was explained that an arrangement contains a lease if it conveys the right to control an identified asset for a period of time. If we have determined what the identified asset is, surely that is the only unit of account?
Thamesha: That’s a great question to start off with Dipthi and you’re quite right, one of the aspects to look at is whether an arrangement contains a lease, and in doing so, assess whether there’s an identified asset.
However, considering the unit of account is important, as the unit of account needs to be determined before applying the lease evaluation framework.
So, before we even get to whether an arrangement contains a lease; and if there is an identified asset, we first need to look at what is the unit of account.
By incorrectly identifying what the unit of account is, this could impact the conclusions reached and therefore the resulting accounting model applied.
Dipthi: Examples always work well, so is there an example that you can share with our listeners to illustrate this concept of determining the unit of account and where this would be applicable?
Thamesha: Of course. So determining what the unit of account is may not be relevant in all scenarios, however let’s take land easements for example.
So, a land easement is basically the right to use, access, or cross another entity or person’s land for a specified purpose.
For example, a telco operator wants to construct a tower on a piece of farm land, and in order to construct and access that tower, it will also need to build a road leading to the tower. The road will also be used by the farmer and others accessing the farm in addition to the telco operator.
The telco operator therefore needs to obtain permission or a right from the farmer to build a road and construct a tower on the farmers land.
So, easements may involve rights to construct assets on the surface of the land, such as the cell phone towers that I just mentioned, these are land or surface rights, or there could be rights below the earth’s surface, for example the laying of a fibre optic cable underground which are your underground or subsurface rights.
Another example where unit of account could be applicable is space allocated to a network operator on a cellphone tower. The network operator could be granted different rights in terms of the space on the tower.
Dipthi: So, in my understanding, if we look at a land easement arrangement that involves surface and subsurface rights, then one would not look at these together, but rather needs to assess whether the unit of account would be each of these rights separately?
Thamesha: That’s correct Dipthi. In assessing what the unit of account is in these types of arrangements, it’s important to note that the unit of account will depend on the nature of the use rights, such as whether it is a surface, land, or subsurface rights, and they may be impacted by whether there are different rights that are granted for different parts of the property.
So, in some instances, the lessee may obtain the right to access a piece of land (so that is the right to build a road on the farmer’s land in the scenario that we spoke about just now) and there could be additional rights to a portion of that land (for example, if the lessee may have exclusive access to a part of the property to construct certain assets such as the cellphone tower).
Arrangements in which the lessee has different rights to different portions of that property, such as surface and subsurface rights may include more than one unit of account.
Dipthi: One could therefore say that if there is more than one unit of account identified, each one would need to be individually evaluated to determine if it represents a lease under IFRS 16.
Thamesha: That’s correct Dipthi, and it may be useful to keep in mind some of the factors to consider under IFRS 16 when evaluating land easements. So these are:
- Firstly, is the unit of account explicitly scoped out of IFRS 16? and
- In determining whether an easement conveys a right to control the use of a specified asset or identified asset, the parties then need to consider the specific provisions of the contract, such as whether the operator’s access rights are exclusive or shared and if there are any landowner substitution rights.
Dipthi: So before you continue, you mentioned shared and exclusive rights. Could you perhaps expand a bit more on what is meant by exclusive or shared rights?
Thamesha: Sure, so let's take a contract where an operator may have a right to lay a cable underground, and this will be underneath farmland. The cable is buried, so it will not block access to the farm nor will it prevent use of that farmland, so the contract gives shared use rather than exclusive use of the land.
- If an arrangement contains the right to have exclusive use of an identified asset, then that is an arrangement that contains a lease in accordance with IFRS 16.
- However, if the agreement provides for shared use, then one needs to evaluate the rights of each party and whether those rights are substantive, such as which party is able to make decisions on how that identified asset is used, and also determine whether the lessee can obtain substantially all of the economic benefits from such shared use, and therefore whether it has the right to control the use of the identified asset.
Dipthi: Thanks Thamesha, that has been quite insightful and I am sure that our listeners now have a much better understanding of why the unit of account is important.
I must say, I found it quite interesting when you mentioned that arrangements could involve subsurface rights and these could potentially be a lease. Who would have thought that you could lease space under the ground?
Thamesha: It is very interesting.. The International Financial Reporting Interpretations Committee or IFRIC for short, actually recently received a request about a particular contract for subsurface rights, in which a pipeline operator, which is the customer, obtains the right to place a pipeline in an underground space for 20 years in exchange for consideration.
The contract in the request specifies the exact location and dimensions, such as the path, the width and the depth of the underground space in which the pipeline will be laid.
The landowner retains the right to use the surface of the land, above the pipeline, but it has no right to access or change the use of the underground space throughout that 20-year period of use.
The customer has the right to perform inspection, and repairs and maintenance work (including replacing any damaged sections of the pipeline for example).
Dipthi: This IFRIC discussion sounds quite familiar. It was asked as to whether IFRS 16, IAS 38 Intangible Assets or another IFRS Standard applies in accounting for the contract.
Thamesha: I see you’re quite on top of the topical issues Dipthi!
Yes, that’s true, and it was basically concluded that the specified underground space in this request is tangible and physically distinct, so in the same way that a specified space above the land’s surface would be physically distinct. The fact that the contract’s specifications include the path, the width and the depth of the pipeline, that defines a physically distinct underground space.
It was also observed that the pipeline operator has the right to obtain substantially all of the economic benefits from the use of that specified underground space and has the right to direct the use of the underground space throughout the 20-year period of use.
The Committee concluded that the contract described in the request contained a lease as defined in IFRS 16.
Dipthi: So taking what you’ve just said and linking back now to the discussion on unit of account, would there be any unit of account considerations in such subsurface type arrangements that you can share?
Thamesha: Yes, there most definitely are unit of account considerations in these types of arrangements. When the dimensions such as the path, the width, the depth etc are specified in the contract, for example in the case of a telco operator laying a cable underground, then that specified space would be the identified asset.
So, it really depends on how specific the contract is. If the contract is not that specific, then you could end up in a situation where there is no lease to account for.
Dipthi: Thanks Thamesha.
So moving on from land easements and subsurface rights onto the more technological side, 5G seems to be on top of everyone’s mind.
I understand that due to new wireless technological developments such as 5G, telco operators often enter into arrangements with other businesses and municipalities to use portions of their infrastructure such as street lights, bus shelters, traffic lights etc to deploy small cell equipment.
I’m assuming that this is also an area in which the unit of account discussions would be relevant?
Thamesha: Yes, most definitely, and perhaps before getting into the unit of account discussion I can quickly explain what is small cell equipment and how this works.
So, small cells allow telcos to expand on its existing macro cell site network to increase capacity and network coverage gaps within a market. Macro cell sites are usually your towers, masts and antennas. Similar to a macro cell site, small cell agreements contain the right to place antennas and radios on existing non-telco specific infrastructure, such as your traffic lights and bus shelters.
Dipthi: That definitely helps in understanding small cell technology. Taking this into account, if a small cell is placed on a traffic light for example, would you consider the traffic light as a whole to be the unit of account, or just the spot on the traffic light where the small cell is placed?
Thamesha: That’s a good question and is actually quite a topical discussion at the moment. There are different perspectives in practice from which the issue can be looked at.
From a US-GAAP perspective, one of the considerations is what is the primary use of non-telco specific infrastructure. So for example if we take the traffic light, one would consider what is the primary use of that traffic light.
From an IFRS perspective, and considering the discussions of the IFRIC and its final agenda decision about the unit of account relating to the subsurface rights that we just spoke about, we believe this could also affect the small cell issue in that the unit of account under IFRS could be interpreted as the place where the technical device will be deployed – and therefore not the asset as a whole. So in the traffic light example, you would consider the place where the small cell is placed, and not the traffic light as a whole as being the unit of account.
Dipthi: Thanks Thamesha for your insights on the unit of account considerations, which has given our listeners much to think about and consider.
We look forward to you joining us again in the studio.
Our listeners can tune into the next Telco Talks podcast where we will discuss topical issues on lease term under IFRS 16.
Thamesha: Thank you Dipthi.
