Telecom’s constant evolution for equipment leasing meets chaos with new lease accounting standards

The silver lining in the race to ASC842/IFRS16 compliance is the opportunity for companies to transform their business operations into an automated process that removes manual spreadsheet analysis and promotes the business efficiencies provided by a subscription-based model.  With the inherent complexities of the Telco lease accounting requirements, solving  ASC842/IFRS16 compliance, Telco transformation – is an opportunity for Telco’s to leverage this unique time to migrate to a managed services solution, as part of their journey to ASC842/IFRS16 compliance.  With the dynamic pace of change required to compete in the Telco space, in order to keep up with technological innovation, companies are scrambling to lease the latest technology – just to stay relevant.  The pace of change is also a driver for the lease accounting teams at Telco’s, as they are constantly modifying lease terms to meet changing infrastructure and network equipment demands, as well as sharing infrastructure to roll out new services without a large capital outlay.

The latest technology for telecoms to ingest is the 5G network technology, which is driving massive change from a software and infrastructure technologies perspective, with each requiring access or acquisition of new delivery capabilities, in order to compete.  Ancillary activities that are needed to support 5G include:

• 5G Network Optimization
• Enterprise Network Visibility
• Advanced Analytics
• Comprehensive Network Security (Tools & Devices)
• Consumption-based/Pay as you go billing

The leasing impact to supporting these business services is enormous, as leasing helps Telecom providers preserve cash flow, provides flexibility for leasing either partial or shared infrastructure costs – making it more affordable to offer premium 5G services to customers at a healthier operating margin.  Click here for additional background on this topic.

5G influence on ASC842/IFRS16 Telecom Compliance

With the 5G evolution, comes an opportunity for telecom providers to modernize their lease accounting and lease management platforms, while concurrently solving for ASC842/IFRS16 compliance teleco transformation.  The speed of 5G (100 MBPS), as well as the speed with which this technology is being rolled out, have left Telecom’s with a lease first strategy, as the timing, cost, and equipment lifecycle make capital acquisitions a nostalgic strategy for telecom’s.

The timing is crucial to market share, which is why the 5G influence is exacerbating to telecom’s – as with year-end compliance deadlines aligned with software and infrastructure upgrades is creating a massive challenge to meet the ASC842/IFRS16 compliance deadlines.  The primary challenges lease accounting teams face is:

1. Most companies do not have a centralized database of all leases. Most leases are tracked in a decentralized manner either on spreadsheets or in employees’ desks in physical locations all over the company
2. The tracking of leases was primarily used for the commitments and contingencies schedules as a disclosure footnote in companies’ public filings. 
3. It is a comprehensive project which will require new processes to be created, tested by management, and vetted by external auditors (Accounting, Treasury, Real Estate, Procurement, Tax, IT)

Significant changes for companies adopting ASC842/IFRS16

Under ASC842/IFRS16, 

1. All leases over an original term of 12 months will be capitalized on the balance sheet
2. Companies will need to determine whether there are any embedded leases within contracts.
3. Each lease of an identified asset where a lessee is deemed to have control will have its own ROU (right of use asset) and related lease liability (present value of future payments)
4. For every lease, a separation of lease and non-lease components will have to be assessed and bifurcated. (Note: There is a practical expedient where companies may combine lease and non-lease components. 

In addition to the asset level accounting detail that will be required for each identified asset (there is a portfolio practical expedient), there are a significant number of new disclosures that will need to be divulged by a company’s equipment portfolio.

New lease footnote disclosures

As required by ASC842/IFRS16, there will be a new leasing footnote as part of the Company’s financial statements. The disclosure objective of ASC842/IFRS16 is to provide the financial statement users sufficient information to assess the amount, timing, and uncertainty of cash flows arising from leases.

• Qualitative disclosures, such as information about the nature of leases (terms and conditions of variable lease payments, extension and termination options, purchase options, residual value guarantees, etc.).
• Quantitative disclosures, such as operating lease cost, amortization of finance lease ROU assets and interest on finance lease liabilities, variable lease cost, weighted-average remaining lease term, weighted-average discount rate, and a maturity analysis of lease liabilities.

Below are some examples of the type of information that will be required in the new leasing footnote which will be part of the Company’s footnotes.

Qualitative

• Information about leases
• Nature of variable payment arrangements
• Termination, renewal, and purchase options
• Information about how the lessor manages residual asset risk, including information about residual value guarantees and other means of limiting that risk
• Significant accounting judgments and estimates

Quantitative

• Maturity analysis of lease receivables for sales-type/direct financing leases and of lease payments for operating leases
• Table of lease income
• Selling profit (or loss) recognized at lease commencement and interest income for sales-type/direct financing leases
• Operating lease income
• Variable lease income

Telecom Entities Impact

For Telecom entity lessees, the adoption of ASC842/IFRS16 may require the recognition of significant assets and liabilities for leases that have traditionally not been recorded on the balance sheet. The reason for this is because of their extensive use of fixed assets under contracts that may qualify as leases under the new guidance. Agreements that Telecom entities enter into are frequently customized and include services and other components critical to completing the contracts, especially in subletting/subleasing arrangements. 

1.      Embedded leases

Within service agreements, there may be embedded leases. As an example of this, an operator hires a service provider to execute the operational portion on a network install. As part of that service contract, there may be an identified asset which the operator has control over. This assessment may potentially identify that there is a lease involved and the accounting that comes with it under ASC842/IFRS16. This may result in the operator capitalizing on the service contractor’s equipment! Therefore, Telecom entities will need to assess many service and lease contracts to determine whether such agreements meet, or have components that meet, the new definition of a lease.

2.      Identifying and separating components of a contract and allocating contract consideration

For contracts that contain the rights to use multiple assets but not land (e.g., a building and equipment, multiple pieces of equipment), the right to use each asset is considered a separate lease component if both of these conditions are met: (1) the lessee can benefit from the right of use either on its own or together with other resources that are readily available to the lessee, and (2) the right of use is neither dependent on nor highly interrelated with, the other right(s) to use the underlying assets in the contract.

3.      Joint Operating Agreements

Telecom entities often enter into joint operating agreements (JOAs), in which two or more parties (i.e., operators and nonoperators) collaboratively develop supporting telecom service offerings. These agreements often require the use of leased equipment. Questions have arisen regarding the lease assessment requirements under the new standard for parties to JOAs. Typically, in JOA’s there is one operator, and this is the entity that will most probably have to capitalize the lease on its balance sheet because that is the entity that is signing the agreement with the service provider for use of its equipment. Once the accounting assessment has been determined that the operator controls the identified asset, then a secondary assessment may be done to assess whether there are any sub-leases between the operator and the non-operators and therefore the same accounting assessment that the operator performed may also be performed by the non-operators to assert whether control exists or not. 

4.      Intra/Intercompany movements

Telecom operators are in the business of leasing properties at various locations to extend their geographical capabilities. As part of the accounting, they will need to be able to track and account for the respective operating costs as the expansion in coverage evolves. 

The need to accurately account for these costs is essential for accurate accounting. The impact of the new leasing standard is such that as an operator identifies that there is a lease resulting from the contract between the operator and the landlord, that cost may potentially be capitalized on the operator’s balance sheet creating a lease liability and a resulting ROU. It is therefore critical to be able to move that ROU asset from location to location and possibly from company code to company as service offerings are extended.

What is the 5G Impact on Telecom ASC842/IFRS16 Compliance: 

Corporate leasing strategies have been highly impacted by the 5G revolution, which has had a huge impact on capital budgets, technology adoption, and migrations to cloud-based computing/SaaS.  These new leases are being added to the backlog of legacy leases, which are all in a queue to evaluate, review for embedded leases and to migrate to a platform for testing and production cutover.

Telecom ASC842/IFRS16 Compliance Key Takeaways

1. Manually tracking of these assets is not of core business value – outsource
2. Companies need a partner to lead the compliance effort, migration and system selection – as the workload is a distraction to business expansion
3. Automation is needed for keeping up with the pace of change, as well as for the ongoing SEC reporting/disclosure statements
4. Experts are required to help guide customers stemming from this new business capability/challenge

Leaseology understands what internal lease accounting teams are up against when it comes to ASC842/IFRS16 compliance and have built an end-to-end solution that allows customers to divert resources, remove cost, increase accuracy/locate cost savings opportunities – all while achieving compliance via an outsourced lease management process.  Although these responsibilities are not always handled by finance/accounting – they are corporate burdens and obstacles to profitability.  Let the experts help you as at the core of the Leaseology service offering, our combination of industry expertise in lease accounting, compliance, reporting and automation can help you meet your compliance timelines – allowing your team to focus on growing your business.

Ken Royce * Leaseology Inc * Board of Directors

ABOUT Leaseology Inc|

Leaseology, Inc is a North America-based business advisory services firm committed to accelerated marketplace adoption of digital technology, financial management innovation, and business operations practice excellence. These core competencies apply to real estate and equipment portfolios.

www.leaseologyinc.com