Accounting for a redefined collaboration

However, there are less radical ways to use assets more efficiently. In PwC’s future in sight series “Shifting patterns”, some customers in the logistics sector are starting their own logistics operations, and new entrants to the industry explore new “sharing” business models.

In the telecommunications industry, telco operators have traditionally adopted a unitary, vertically integrated model, where the core network, backhaul, and base stations are all owned and managed internally. With this model, network coverage was a key to market differentiation. Telco operators naturally carry a lot of capital expenditures in their balance sheet. As better coverage became a competitive advantage and delivered good returns to telco operators, more and more telco towers have been built.

Today, market differentiation is shifting away from network coverage. The potential to reduce operating and capital costs, and reducing the burden of asset management, can help telco operators be more effective in delivering better customer experience.

In recent months, the Department of Information and Communications Technology released initial guidelines of the Common Tower and Pole policy. This will allow tower
operators to lease telco towers to existing and new telco operators.

Shared telco tower arrangements or tower sharing have implications for both capital and operational costs.

Meanwhile, tower-sharing arrangement may come in many forms, with arrangements that include the right to use a specified tower; a specified term of use; legal title not being transferred; and a number of associated service agreements, including operations and maintenance. The accounting treatment is determined by reviewing the terms of the arrangement and understanding the arrangement’s commercial substance. Usually, tower sharing constitutes a lease because the fulfillment of the arrangement depends on the use of the tower space and the arrangement conveys the right to use the asset.

Under the existing accounting standard, the Philippine Accounting Standard (PAS) 17, lessees account for lease transactions either as operating, or as finance, leases depending on complex rules and tests which, in practice, use ‘bright-lines’ resulting in all or nothing being recognized on balance sheet for sometimes economically similar lease transactions.

With the implementation of the new lease standard, the Philippine Financial Reporting Standard (PFRS) 16, beginning Jan. 1, 2019, the distinction between operating and finance leases is eliminated for lessees. Except for some short-term leases and low value assets, a new lease asset (representing the right to use the leased item for the lease term) and lease liability (representing the obligation to pay rentals) are recognized for all leases.

Restoration cost continues to be included in the measurement of the right-of-use model. Any subsequent change in the measurement of the provision, due to a revised estimation of expected restoration costs, is accounted for as an adjustment of the right-of-use asset.

With tower operators looking to expand their network footprint quickly, and with no finalized regulations on prohibited transactions, telco operators may consider unloading their balance sheets. They can do this by selling outright their telco towers to tower operators, or selling to and leasing back towers from tower operators.

The accounting for sale and leaseback transactions under PAS 17 mainly depended on whether the leaseback was classified as a finance or as an operating lease. Under PAS 17, a lessee defers the gain upon sale if the leaseback is classified as a finance lease.

If a sale and leaseback transaction results in an operating lease, and it is clear that the transaction is established at fair value, any profit or loss shall be recognized immediately.

If the sale price is below fair value, any profit or loss shall be recognized immediately except that, if the loss is compensated for by future lease payments at below market price, it shall be deferred and amortized.

If the sale price is above fair value, the excess over fair value shall be deferred and amortized.

Under PFRS 16, the starting point is whether or not the seller-lessee actually has a sale first, so the guidance points to PFRS 15.

If the transaction does not meet the definition of a sale, i.e. when control has not been effectively passed across to the buyer-lessor, then it is accounted for as if it’s a secured loan against the asset, the seller-lessee will still have the asset on balance sheet and will have a new liability. This could happen if the seller-lessee has sold an asset and has a right to buy it back at any time below market value, then control had not really been transferred.

If the transaction has passed on control, so that it is a sale and lease back, then the seller-lessee will de-recognize the original asset, and recognize a right-of-use asset for the proportion of the carrying amount of the right-of-use asset retained.

Sale and lease back under the PFRS 16 might not be quite attractive for financial reporting, but this arrangement provides some cash flow benefit, since the seller-lessee will receive cash and continue to use the same asset.

The new standard will affect virtually all commonly used financial ratios and performance metrics such as earnings before interest, tax, depreciation and amortization (EBITDA), operating profit, net income, earnings per share (EPS), return on equity (ROE) and operating cash flows. Balance sheets will grow, gearing ratios will increase, and capital ratios will decrease. As telco operators continue to assess the impact of the new lease standard, opportunities presented by tower-sharing arrangements, lease negotiations and capital expenditure planning will be an important board agenda.