International Financial Reporting Standards (IFRS) will have a key impact on all convergence firms in the telecom, media and technology (TCE) sectors in myriad ways.
These firms will have to implement component basis of accounting for fixed assets—these assets will get classified into different categories depending on their useful life and depreciation. Whenever any component of a fixed asset will get replaced, its cost will be capitalized and the old components net written-down value will be removed from the fixed assets block. This will be a significant change for telecom firms, which are quite capital intensive. Further, for telecom base terminal stations and tower sites, the costs for site restoration would need to be factored upfront and included in the cost of the asset components. The major challenge here would be that many times it may not be evident from the contract whether an obligation exists or not. In IFRS, a provision would have to be made based on constructive obligation rather than legal obligation, so in all probability, such costs would need to be estimated and provided at the inception period of the terminal station or base site.
For telecom firms, it will be critical to evaluate whether provision/receipt of infrastructure services constitutes or contains a lease arrangement under IFRIC-4 on Determining whether an Arrangement contains a Lease, particularly since it involves use of specific assets with a right to control the use of the asset.
It is expected that their financial statements would change significantly if it is determined that such transactions contain an element of lease and more so if it satisfies the criteria for a finance lease. Under Indian GAAP, such arrangements are considered as those for providing services and not a leasing activity. Technology firms may also have such arrangements under outsourcing contracts, data storage or network facility use arrangements, where IFRIC-4 will need to be evaluated for applicability.
Telecom companies provide package offers comprising handset, prepaid minutes, messages, discounts, special offers and other incentives. Technology firms also enter into lump sum contracts for sale of licences, implementation fees, warranty, maintenance and free upgrade services over a period of time. Media firms often bundle and market space across various products, programmes or channels and publications/portals. Under IFRS, a key issue will be to determine whether the various components of a transaction can be separated from an obligation performance standpoint and commercial perspective. In such cases, bundled contracts and multiple offerings under a package will require fair valuation of different components and revenues would be recognized accordingly. Indian GAAP does not provide any specific guidance on this and hence, inconsistent practices are presently being followed by various firms.
Under IFRS-2 on “Share-based Payment”, share-based payments also cover non-employees. If certain non-employee obligations are settled through employee stock options (Esops), IFRS will require fair value accounting for such options and cost differential between grant price and fair value will have to be recognized, either as a reduction of revenue or operating expense. Moreover, subsidiaries will need to account for Esop costs for options granted to its employees by the parent company with corresponding impact in capital contribution by the parent as per the requirement of IFRIC-11 on IFRS 2—Group and Treasury Share Transactions. This is not required under Indian GAAP. Another key aspect is that Indian GAAP allows intrinsic method of accounting. Here the Esop cost is generally lower since it only takes into account the value of the option as at the date of its grant and does not capture the likely accretion in fair value over the entire vesting period. Share based payment costs are expected to increase on application of IFRS.
Media firms also have common practice of giving advertising space for other services. These barter transactions would need to be accounted for using fair value method, provided that goods sold or services rendered are in exchange for dissimilar goods or services. Indian GAAP is largely inadequate on this matter, resulting in varying accounting practices.
IFRS entails discounting of receivables and payables to their current values using expected interest rates. In telecom firms, this concept of time value of money will have impact on the amounts recorded for long-term security deposits, payables falling due after a year and revenues earned in advance for long-term subscription arrangements.
In summary, convergence to IFRS for the new-age convergence firms is not going to be a cakewalk and will need significant preparation well in advance, so that they are ready for the IFRS Goes Live event effective 1 April 2010.
India will move to IFRS starting 2011. Navin Agrawal is a director with Ernst &Young India Pvt. Ltd. This is the sixth in a series that analyses the impact of IFRS on industries and regulatory issues pertaining to its convergence with Indian GAAP. Respond to this column at firstname.lastname@example.org
Also Read Navin Agrawal’s earlier columns