Accounting rule changes mean telecoms firms have to invest in IT and find new ways of doing business

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Stand by for major changes in the rules about how operators account for revenue, says Holger Forst. That will affect not only the financial people in a company but the IT and marketing plans too. Co-sponsored feature: EY

Holger Forst: The telecoms industry lobbied hard against that
rule, with only very limited success. The new accounting
regulations might have an impact on the real business 
Further reading: Revenue recognition: CFOs admit to big challenges as they plan to implement new global accounting rules. Six leading CFOs talk to Global Telecoms Business about the GAAP/IFRS changes

Telecoms operators worldwide need to be prepared for huge changes in the way they recognise and account for revenue — changes that will be implemented in the next two years.

Operators campaigned against the new standards, which will require them to invest heavily in new IT systems and will markedly affect the way they state their results. But they lost the fight and they will have to implement the new rules from December 2016.

That gives them a little over two years to take major decisions before implementing and testing the new processes and systems — and to prepare shareholders and bankers for the inevitable changes in results.

“The new standard is not only an accounting exercise,” says Holger Forst, global telecommunications markets leader at EY. “There will be an impact on profit and loss, on key performance indicators, on systems. There is a need to get all stakeholders on board. The implementation will be costly and time consuming. It’s critical to kick the projects off now.”

The people behind the new rules on revenue recognition are the Financial Accounting Standards Board, whose primary purpose is to establish and improve generally accepted accounting principles in the US, and International Financial Reporting Standards, which are applied globally.

But why make the changes? US generally accepted accounting principles — or GAAP — were different from IFRS in the way they recognised revenue. “The old international standard was very general,” says Forst. US GAAP appeared to have a more detailed approach, but there was little consistency in how different companies accounted for revenue.

“The organisations decided to produce a joint approach.” A more sophisticated standard would aid comparability and better reflect companies’ actual performance.

“This affects all industries but telecoms was one of the loudest in the lobby against the new standard.” That’s because telecoms operators — fixed and mobile — have many historic practices which have fitted comfortably with the old rules.

Device subsidies for example — and not just the explicit offers in mobile phone shops which offer the latest Apple iPhone or Samsung Galaxy for just a few dollars as part of a long-term service contract. What about the wifi hub, set-top box or personal video recorder that fixed broadband and cable companies offer as temptations to their customers?

“The new rules will have a significant impact on a lot of areas,” says Forst. One of the major changes is that the rules will “accelerate the time when you recognise revenue. The total revenue across the period of a contract will not change, but some companies will have to recognise revenue earlier than in the past.”

Under the rules, operators need to record a “fair value” for all the components in a bundle. “In the old days, you could provide a subsidised handset for a $1 as part of a 24-month contract. The revenue that you needed to recognise was capped at that $1.”

But under the new rules, “if the fair value of that handset is $300, you will need to recognise all that revenue the moment the customer signs the contract that equals the relative fair value of the handset in relation to the revenue for the entire contract”, says Forst. “So now there is a difference between the cash taken and the recognition of the revenue.”

The telecoms industry lobbied hard against that rule, and lost. “They wanted an industry opt-out on the cash cap but they failed to win the argument.”

Revenue no longer equals cash

The new rules will clearly affect a company’s profit and loss statement. “From an accounting perspective, you cannot continue with the idea that ‘revenue equals cash’,” he says.

But the telecoms industry moves so quickly that the fair value of a particular device may change. “Companies are changing their prices and offers more or less every month.” So the accounting software will have to track these changes, even on existing contracts.

And, as new devices emerge, customers may decide to upgrade before the end of the 24-month contract. What happens then?

“This isn’t a one-time adjustment,” says Forst. Companies will have to upgrade their systems so that they can track and adjust for all these changes. “That was the industry’s major argument when these new rules were being proposed. This is not just a matter for the accounting department. They will have to make sure they’re reporting to the new standards but a lot of other departments will need to be involved.”

Which other departments? Controlling, IT, internal audit, revenue assurance, for a start, says Forst. “And product development.” The new rules will have a significant impact on the value of new products and services.

Impact on real business

“People in the industry are saying this might mean the accounting regulations will have an impact on the real business — on the way operators offer bundles and subsidies and the way contracts are offered.”

One of the biggest headaches for the industry is that are millions of different contracts and the new rules will apply to each. One of the industry’s main successes when it was lobbying FASB and IFRS was the acceptance of a proposal that operators could bundle broadly similar contracts into a portfolio. Then, the idea is, a common formula can be applied to the whole bundle to bring it into alignment with the new rules.

“When this portfolio approach was introduced in the second draft of the standard a lot of people in the industry thought this was a silver bullet to solve the problem,” smiles Forst.

But it is not. “The more and more than we look into it we find that to identify and approve a portfolio we will need to have the same level of data as if we were making the adjustment contract by contract. There are more and more question marks,” he warns.

“Some operators are trying to take on very broad portfolios and they’re combining them with a sophisticated mathematical formula, which might work. But they will have to test and document the internal controls. And you will have to provide proof of the mathematics,” so that auditors can examine the assumptions that were made to derive the formula.

However operators decide to face the challenge, the date of introduction is fixed. Public entities will have to apply the standard for fiscal years starting after 15 December 2016, including interim periods within those years — which means that we will see the new standards being applied to quarterly results from March 2017.

“There won’t be any extra time,” says Forst. “Perhaps 2017 sounds far away but there is a lot to do. In fact, the more you dig the more you find.”

Billing system changes

Telecoms companies are famous, for example, for having a multiplicity of billing systems — perhaps one for each service, numbering dozens in all. Each will have to be amended to conform with the new requirements.

“This will be a large project that will require lots of resources in every operating company. And companies will need a lot of external help to implement approved IT solutions.”

Move quickly, he says, but don’t make “too early decisions” on key areas such as whether to go for the contract-by-contract approach or the portfolio approach.

“You need to know where the information is.” And the accounting team will need new information — for example, about how many contracts go to the full term and how many are terminated early, perhaps because a customer upgrades to a new smartphone.

What happens when a new iPhone comes out and many of your customers want to upgrade much earlier than expected? “This was one of the examples operators used when they were lobbying against the standard,” says Forst.

The accountancy people will need to know if a contract initially expected to be 24 months is replaced after 18 with a new one: the revenue will have to be recognised over a shorter period.

The financial team will have to go through all of a company’s business and ask: “Do we have the information we need to prepare the accounts, and is this information reliable as the basis of our accounting decisions? Can we get all the information we need from the company’s data warehouse?”

Profit and loss impact

That’s why, he says, “the new standards will certainly have an impact on profit and loss and on key performance indicators”.

Here’s another example of a change that will be coming as a result of the new rules. How do operators regard commissions and other sales costs? “Today most operators expense the subscriber acquisition costs,” says Forst. “The new standard says they will have to regard it as capital expenditure and amortise it over the life of the contract.” And the lifetime of the contract, of course, may not be predictable at the start: further uncertainty.

Chief financial officers are in no doubt about the size of the challenge facing them, says Forst. “From all the discussions we’ve had, CFOs and heads of accounts are saying they want to do it properly. We don’t see anyone wanting to take short cuts.”

Some larger operators have already started the process, as soon as the last draft of the standard was accepted at the end of 2013. That means they are at the front of the queue for the extra resources that will be needed: those who wait will have to look harder and pay more.

Operators need to allocate a budget for all the changes that they will have to implement. The scale of the work may mean that other IT projects, for example, will need to be set aside for a couple of years. “It’s not just about the cost, but companies will need to allocate the time and the resources and the IT skills.”

There is constant pressure within companies to update IT systems, “but because of the new accounting rules, revenue recognition is non-negotiable,” says Forst. “These changes will have an impact on companies’ development over the next two or three years. They have to be on the agenda of the C-level executives.”

What will happen to those companies that bury their heads in the sand and don’t implement the changes in time? “Who will sign off their accounts?” he asks. Companies will face litigation if they don’t do everything in time. “But if they lose time it will be more and more expensive.” 

Further reading: Revenue recognition: CFOs admit to big challenges as they plan to implement new global accounting rules. Six leading CFOs talk to Global Telecoms Business about the GAAP/IFRS changes