IAS 36 Best brilliant impairment of telecom assets

IAS 36 Best brilliant impairment of telecom assets sets out the procedures that an entity should follow to ensure that it carries its assets at no more than thIAS 36 Best brilliant impairment of telecom assetseir recoverable amount. Recoverable amount is the higher of the amount to be realised through using or selling the asset.

Where the carrying amount exceeds the recoverable amount, the asset is impaired and an impairment loss must be recognised.

The standard details the circumstances when an impairment loss should be reversed, and also sets out required disclosures for impaired assets, impairment losses, reversals of impairment losses as well as key estimates and assumptions used in measuring the recoverable amounts of cash-generating units (CGUs) that contain goodwill or intangible assets with indefinite lives.

The standard does not apply to assets that are covered by other standards: IAS 36 Best brilliant impairment of telecom assets

In scope of IAS 36

Out of scope of IAS 36

Property, plant and equipment IAS 36 Best brilliant impairment of telecom assets

Inventories (IAS 2) IAS 36 Best brilliant impairment of telecom assets

Contract assets and contract costs to obtain or fulfil a contract (IFRS 15)

Deferred tax assets (IAS 12) IAS 36 Best brilliant impairment of telecom assets

Assets arising from employee benefits (IAS 19)

Financial assets (IFRS 9) IAS 36 Best brilliant impairment of telecom assets

Investment property (IAS 40) IAS 36 Best brilliant impairment of telecom assets

Biological assets at fair value less costs to sell (IAS 41)

Assets for insurance contracts (IFRS 17)

Non-current assets (or disposal groups) held for sale (IFRS 5)

Intangible assets, including goodwill

Financial assets classified as:

  • Subsidiaries IAS 36 Best brilliant impairment of telecom assets
  • Associates IAS 36 Best brilliant impairment of telecom assets
  • Joint ventures IAS 36 Best brilliant impairment of telecom assets

IAS 36 Best brilliant impairment of telecom assets

IAS 36 Best brilliant impairment of telecom assets

IAS 36 requires at least annual impairment tests for goodwill, other intangible assets assigned an indefinite useful life, and intangibles not yet available for use. Moreover, for any asset, an impairment test has to be carried out at each reporting date if there is any indicator of impairment (a triggering event):

IAS 36 Best brilliant impairment of telecom assets

Standard

Test basis

Impairment test

Tangible assets

IAS 16

Asset or CGU

Test for impairment only after ‘triggering event’:

recoverable amount compared to carrying amount

Intangible assets with definite useful life

IAS 36

Asset or CGU

Intangible assets with indefinite useful life

IAS 36

Asset or CGU

Test at least annually and after ‘triggering event’:

recoverable amount compared to carrying amount

Goodwill

IAS 36

CGU only or group of CGUs

With regard to triggering events, IAS 36 gives a list of common indicators of impairment from external and internal sources of information that should be considered, such as: increases in market interest rates, market capitalisation falling below net asset carrying value or the economic performance of an asset being worse than projected in internal budgets.

Other specific indicators for telecom companies might be: IAS 36 Best brilliant impairment of telecom assets

  • Adverse trends in performance indicators such as network utilisation rates, average revenue per user (ARPU), the number of customers, churn and cost per gross addition
  • Network operating or maintenance expenditure significantly in excess of the original budget
  • Technological developments that may reduce the economic performance of an operating licence (i.e. the technology related to the licence becomes obsolete)IAS 36 Best brilliant impairment of telecom assets
  • Market entries of new competitors (e.g. auction process for additional licences)
  • Impact of changes in regulation and deregulation IAS 36 Best brilliant impairment of telecom assets

The standard states that the impairment test should be carried out at the level of individual assets, where practical, or as part of a CGU. A CGU is the smallest identifiable group of assets, including the asset under review, that generates cash inflows that are largely independent from other assets or groups of assets.

However, goodwill does not generate cash flows independently of other assets or groups of other assets. Goodwill, therefore, has to be tested at the level of either a CGU or group of CGUs.

Asset impairment tests

Typical intangible assets at telecom companies, besides goodwill, are telecom licences, internally developed software, subscriber acquisition costs and customer relationships, brands and trademarks acquired in a business combination. Generally, except for brands, these assets have a definite useful life.

A definite useful life means the assets are amortised on a regular basis and are tested for impairment only if there is an indication that the asset might be impaired. In the past, the useful life of company brands was often classified as indefinite. IAS 36 Best brilliant impairment of telecom assets

However, market evidence shows that telecom companies often rebrand acquired companies within a few years of the acquisition. Thus, in recent purchase price allocations it can be observed that a definite life is generally chosen. In some cases, telecom licences have an indefinite useful life and have to be tested at least annually for impairment.

Something else -   Deferred tax assets Future tax profits

Telecommunications licences

Telecom licences, in general, should be amortised on a systematic basis over the best estimate of their useful lives. The presumption for intangible assets is that straight-line is the most appropriate basis of amortisation. Telecom licences are underpinned by a legal agreement and a stated term.

The useful life of a telecom licence generally will be the period from when the licence becomes available for use to the end of either its remaining legal term or the period over which the licence is expected to bring economic benefits, whichever is earlier. Where telecom licences have a history of being renewed at insignificant cost, it may be possible for the useful life to extend beyond the contract term, but that would be unusual. IAS 36 Best brilliant impairment of telecom assets

Many mobile network operators have paid significant amounts for licences, particularly for 3G licences. Some mobile network operators have recognised impairment losses because related data services were launched later than expected or customers have not embraced them, and revenues were lower than initially expected.

Continued technological developments in the future may lead to licences becoming obsolete, although there is a general trend towards licensing authorities issuing ‘technology neutral’ licences.

In practice, the impairment test for licences is often performed by deriving multiples from comparable licence auctions or transactions (the market approach) or by applying the ‘greenfield’, or build-out, approach. The greenfield approach is a specific income approach that assumes a company has only one asset (the licence) as the basis for building up its business.

Although the market values derived from comparable auctions or transactions may have fallen significantly in many cases, the carrying amount of the licence may still be supported on the basis of the value in use derived from the expected future cash flows generated from operating the network. IAS 36 Best brilliant impairment of telecom assets

Thus, when applying a value in use approach, telecom licences should be assessed for impairment together with the related network assets, as the licences do not generate independent cash flows.

Acquired customer relationships

Acquired customer relationships should be amortised on a systematic basis. Sharp decreases in ARPU, however, or an unusually high level of churn may be triggering events that necessitate an impairment test. IAS 36 Best brilliant impairment of telecom assets

In the past, the valuation of customer relationships of mobile network operators, broadband access or internet services companies in purchase price allocations has been based on high revenues per customer. That approach has resulted in comparatively high carrying amounts. Customer relationships are more frequently valued by applying the multi-period-excess-earnings method (MEEM). IAS 36 Best brilliant impairment of telecom assets

The MEEM approach requires projecting the future revenues and expenses attributable to the customer relationships, which generally are considered the main asset. The main asset generates earnings and is essential to a company’s ability to compete in the industry. MEEM also considers the contributing assets, such as the network, by way of so-called contributory asset charges in the derivation of the fair value. IAS 36 Best brilliant impairment of telecom assets

If the fair value of customer relationships is determined during the purchase price allocation based on the MEEM approach, then when conducting impairment testing, the fair value less the costs to sell can generally be determined for the individual asset (i.e. the customer relationships).

If the resulting fair value less the costs to sell is below the carrying amount, a value in use calculation of the customer relationships together with the appropriate network assets should generally be performed, as customer relationships do not generate cash flows that are independent of other assets of the business.

Acquired brands and trademarks

In the telecoms industry, acquired brands and trademarks are generally amortised based on an estimated remaining useful life, which is often limited by when the acIAS 36 Best brilliant impairment of telecom assetsquirer plans to rebrand the acquired company. IAS 36 Best brilliant impairment of telecom assets

However, the launch of new brands by competitors or a worsening of the company’s market perception could be triggering events which would require an impairment test.

Brands or trademarks may be considered to have an indefinite useful life, in which case they are tested at least annually for impairment.

Typically, brands are valued in the course of purchase price allocations by applying the relief-from-royalty method (income approach). That method determines the present value of royalties saved due to the ownership of the brand over its useful life. IAS 36 Best brilliant impairment of telecom assets

For impairment test purposes, the fair value less the costs to sell of the brand and trademarks can be determined in a similar manner to the purchase price allocation based on the relief-from-royalty method. IAS 36 Best brilliant impairment of telecom assets

However, if the resulting fair value less the costs to sell is below the carrying amount, a value in use calculation has to be carried out at the CGU level, as brands and trademarks generally do not generate cash flows that are independent of other assets of the business. IAS 36 Best brilliant impairment of telecom assets

Goodwill impairment test

Something else -   Debt instrument

According to an analysis of annual reports, the impact of impairment losses on intangible assets (except for goodwill) on the earnings of telecom companies does not seem that significant.

Thirteen companies reported an average €31 million impairment loss on intangible assets with definite useful lives, and two companies reported an average €19 million impairment loss on intangible assets with indefinite useful lives – based on a total sample of 23 companies4.

In contrast, goodwill impairments are much more significant, as six companies from this sample reported an average €530 million impairment loss. This average was skewed due to a single impairment charge of €2.7 billion by a French operator. IAS 36 Best brilliant impairment of telecom assets

However, an earlier analysis of annual reports also found significant levels of goodwill impairment in the telecoms industry, with nine of 26 companies reporting goodwill impairment losses of, on average, €4.0 billion5. IAS 36 Best brilliant impairment of telecom assets

In 2005 the average value was driven by two individually significant cases of a United Kingdom and a German telecom operator writing down their goodwill positions by €34.2 billion and €1.9 billion, respectively. IAS 36 Best brilliant impairment of telecom assets

Test level

The standard requires that “for the purpose of impairment testing, goodwill acquired in a business combination shall, from the acquisition date, be allocated to each of the acquirer’s CGUs, or groups of CGUs, that is expected to benefit from the synergies of the combination, irrespective of whether other assets or liabilities of the acquiree are assigned to those units or groups of units” (paragraph 80). IAS 36 Best brilliant impairment of telecom assets

Besides having largely independent cash inflows, the unit or group of units to which the goodwill is allocated shall meet the following criteria:

  • Be the lowest level within the entity at which the goodwill is monitored for internal management purposes
  • Not be larger than an operating segment, as defined in IFRS 86

The independence of cash inflows will be indicated by the way management monitors the business’ activities, for example by product lines or locations. Network operators need to consider whether the network can be treated as a single CGU; whether fixed and mobile businesses are monitored separately as a single CGU; and whether the 2G business is independent of the 3G business. IAS 36 Best brilliant impairment of telecom assets

Based on the analysis of annual reports, CGUs generally follow legal entities but are often further differentiated between fixed and mobile businesses. For (external) reporting purposes these CGUs are often summarised into geographical clusters in accordance with the respective segments7. IAS 36 Best brilliant impairment of telecom assets

In light of increasing convergence, (particularly increased product bundling of fixed and mobile services or internet and voice services), the identification of CGUs is becoming more complex.

Thus, there is an increasing tendency in the market for telecom companies to aggregate mobile and fixed business8. Some, for example Swisscom, avoid this complexity altogether by differentiating their CGUs based on customer type, for example: consumers, small and medium enterprises, large companies and wholesale9.

Most publicly available data, such as annual reports, does not include the exact level at which the goodwill impairment test has been performed, as IFRS does not require companies to disclose such detailed information. IAS 36 Best brilliant impairment of telecom assets

However, the segments reported represent the maximum level to which goodwill can be allocated, because IAS 36 requires that a CGU cannot be larger than an operating segment determined in accordance with IFRS 810. IAS 36 Best brilliant impairment of telecom assets

Carrying amount

Goodwill impairment testing requires a comparison of the carrying amount of the CGU which contains the goodwill with its recoverable amount. The carrying amount of a CGU shall be determined on a basis consistent with the way the recoverable amount of the CGU is determined (IAS 36 75). IAS 36 Best brilliant impairment of telecom assets

The following chart gives an overview of how to determine the carrying amount of a CGU: IAS 36 Best brilliant impairment of telecom assets

Net working capital (current assets less current liabilities) IAS 36 Best brilliant impairment of telecom assets

+

Directly attributable assets (non-current tangibles and intangibles) IAS 36 Best brilliant impairment of telecom assets

+

Allocated goodwill (100% basis) IAS 36 Best brilliant impairment of telecom assets

+

Allocated share of corporate assets IAS 36 Best brilliant impairment of telecom assets

Attributable non-current liabilities where applicable IAS 36 Best brilliant impairment of telecom assets

=

Carrying amount of the Telecom Cash-generating unit

The allocated carrying amount of goodwill needs to be grossed up on an acquisition of less than 100% of the shares, to include the goodwill attributable to the minority interest.

Something else -   IAS 36 Determine if and when to test for impairment

Recoverable amount

The recoverable amount of an asset is defined as the higher of the fair value less costs to sell (FVLCTS) and its value in use (VIU). IAS 36 19 emphasises that it is not necessary to determine both values: if either of the two measures exceeds an asset’s carrying amount, the asset is not impaired, and the company is not required to estimate the other measure.

Fair value less cost to sell and value in use

The following table summarises the differences in the concepts of fair value less costs to sell and value in use: IAS 36 Best brilliant impairment of telecom assets

IAS 36 Best brilliant impairment of telecom assets

Fair value less costs to sell

Value in use

Perspective

Hypothetical buyer – market participants’ perspective

Internal value – company specific perspective

Valuation approach

Market approach or Income approach

Income approach only

Cash flow projections

IAS 36 Best brilliant impairment of telecom assets

IAS 36 Best brilliant impairment of telecom assets

  • Eliminate all owner-specific synergies
  • Adjust all projections such that assumptions are consistent with those of market participants
  • Consider restructurings as well as enhancing investments if usual in the market
  • Consider cash flows related to financing and taxes
  • Recognise all synergies
  • Eliminate all effects from restructurings, if no provision in accordance with IAS 37 has been made
  • Eliminate all effects from enhancing investments; only maintenance investments should be incorporated
  • Exclude cash inflows or outflows from financing activities
  • Exclude income tax receipts or payments

Discounting rate

IAS 36 Best brilliant impairment of telecom assets

IAS 36 Best brilliant impairment of telecom assets

  • Post-tax weighted average cost of capital (WACC) considering market participants’ view
  • A peer group should reflect the market participants (hypothetical buyer)

IAS 36 Best brilliant impairment of telecom assets

IAS 36 Best brilliant impairment of telecom assets

  • Generally, IAS 36.55 requires applying a pre-tax discount rate; regularly in practice, post-tax rate is used to determine an appropriate pre-tax rate
  • Discount rate to be determined using the WACC of the CGU or company as a starting point
  • Some CGUs may require the use of WACC derived from a peer group

When the FVLCTS is derived by using estimation techniques such as a discounted cash flow, some of the restrictions imposed by IAS 36 on the VIU approach do not apply. For example, the cash flow projections can include the effect of restructurings, reorganisations or future investments in the network. IAS 36 Best brilliant impairment of telecom assets

This is because all rational market participants would be expected to undertake these expenditures and reorganisations in order to extract the best value from the purchase and, hence, they would have been factored into the acquisition price. Thus, in cases where a restructuring is anticipated but has not yet been provided for, a valuation based on the FVLCTS might be higher than one based on the VIU. IAS 36 Best brilliant impairment of telecom assets

It is important that when comparing the carrying amount with the recoverable amount, entities ensure that the carrying amount of the CGU being tested for impairment is calculated on a consistent basis with the cash flows included in either the FVLCTS or the VIU calculation. A FVLCTS valuation, therefore, should be compared with the assets of the CGU including any tax balances, whereas a VIU recoverable amount would be compared to assets excluding the associated tax. IAS 36 Best brilliant impairment of telecom assets

IAS 36 Best brilliant impairment of telecom assets

Annualreporting provides financial reporting narratives using IFRS keywords and terminology for free to students and others interested in financial reporting. The information provided on this website is for general information and educational purposes only and should not be used as a substitute for professional advice. Use at your own risk. Annualreporting is an independent website and it is not affiliated with, endorsed by, or in any other way associated with the IFRS Foundation. For official information concerning IFRS Standards, visit IFRS.org or the local representative in your jurisdiction.

Something else -   Recoverable amount

Leave a comment