IFRS 16: Unit of account – Episode 2 (Podcast)

IFRS 16: Unit of account – Episode 2 (Podcast)


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. Hi Dipthi, thank you. I’m very excited to
be part of the podcast series. 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? 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. 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? 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 cell phone tower on a piece of farm land, however, in order to construct and access that tower, it will
also need to build a road leading to the tower. The road will also need to be used by the farmer and
others accessing the farm in addition to the telco operator. The telco operator therefore has to obtain
the permission or the right to use the land to build the 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 that are below the surface of the earth, for example the laying cable underground, these are your subsurface or underground rights. Another example of where the units of account may 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. 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? 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,
air 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, a lessee may obtain
the right to access a piece of land (that is the right to build a road on the farm as I mentioned earlier), and it may also have additional rights
to a portion of that land (for example, it may have exclusive access to a
part of the property where ti has the right to construct certain assets such as the cellphone tower). Arrangements in which the lessee has different
rights to different portions of the property, such as surface and subsurface rights may
include more than one unit of account. One could therefore say that if there is more
than one unit of account identified, each one would then need to be individually evaluated
to determine if it represents a lease under IFRS 16. That’s correct Dipthi, and it may be useful
to keep in mind some of the factors in the IFRS 16 evaluating pertaining to 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 party should consider whether there are specific provisions of the contract, so for example, is the operator’s access right exclusive or is there shared rights if there are any landowner substitution rights.
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? 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 rather than exclusive use of the land. If an arrangement contains the right to have
exclusive use of an identified asset, then the lease, er, the contract contains a lease in accordance with IFRS 16. However, if the agreement provides for shared
use, then one will need to evaluate the rights of each party and whether those rights are
substantive, so then we will need to consider who is able to make the relevant decisions about how that asset is used, and also determine whether the lessee obtain substantially all of the economic
benefits from such shared use, and therefore whether it has the ability to control the use
of the identified asset. 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? 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 this request there was a pipeline operator,
which is the customer, obtains the right to place a pipeline in an underground space for
20 year period of use 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 does not have 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). This IFRIC discussion sounds familiar.
It was asked as to whether IFRS 16, IAS 38 Intangible Assets or another IFRS Standard
applies in accounting for these types of contracts. I see you’re quite on top of the topical
issues Dipthi! Yes, that is 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 are of space on a land surface would be physically
distinct. The fact that the contract specifications include the path, the width and the depth
of the pipeline, this 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 in that contract
described in the request, that this was a lease as defined in IFRS 16. 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? 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, that specified space would be the identified
asset. So, it really depends on how specific the
contract is. So if the customer, sorry, if the contract is not that specific, it could end up that there is no lease to account for. 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? 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 infrastructure, such as your bus shelters and traffic lights. That definitely helps in understanding small
cell technology. Taking that 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? 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 to consider what is the primary purpose of that 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 serves. From an IFRS perspective, with a view to 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 that 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 is deployed and therefore not the asset
as a whole. 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. Our listeners can tune into the next Telco
Talks podcast where we will discuss topical issues on lease term under IFRS 16. Thank you Dipthi.

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