Introduction to Applying IFRS for telecommunications entities

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1 1 of 10 8/15/2008 4:50 PM close window Global home Introduction to Applying IFRS for telecommunications entities Contents Introduction The telecommunications industry Intangible assets Property plant and equipment (PP&E) Indefeasible Rights of Use ("IRUs") and capacity arrangements Impairment of network assets and telecom licences Inventories Revenue recognition Introduction The telecommunications industry is capital-intensive, with operators investing heavily in licences and network infrastructure. Deregulation, increased competition and technological advances characterise the industry. Operators have responded by offering complex bundled arrangements to customers through a range of different distribution channels, and by investing in the acquisition and retention of customers. Use the quick links below to access specific components, solutions and related publications. Linked components - Select - Linked publications -Select- Linked solutions - Select - Significant accounting issues arise for telecommunications operators in the area of property, plant and equipment constructed, purchased or swapped, and operators often have complex revenue recognition issues. Telecommunications operators must apply all of the requirements of IFRS that are applicable. Applying IFRS for telecommunications entities highlights transactions and accounting issues that are particularly relevant to the industry. Reference for most issues should be made to the general version of Applying IFRS. These telecommunication entities solutions provide guidance, responding to the specific facts and circumstances given in the background. The issues are complex, and it is impossible to provide guidance for every fact pattern. The examples included within Applying IFRS for telecommunication entities solutions are for guidance only, and technical advice should be sought when appropriate. The telecommunications industry The telecommunications industry is a rapidly-changing industry operating across a broad spectrum, including simple voice telephone calls, access to the Internet, high-speed data communications, satellite communications and the World Wide Web. The industry is broadly split in two: a) Fixed-line sector. A fixed communication network physically links two or more static devices (telephones, facsimile machines, computers, television) by electric cable or optical fibre. The fixed telephone network was originally an analogue network that carried voice traffic only. Technology in the last 20 years has moved towards digital networks. Operators have invested significant amounts in the construction of integrated digital networks that are capable of carrying data traffic as well as voice. Each country traditionally had a single fixed-line operator that was government-owned or a regulated monopoly. Deregulation has resulted in the break-up of these monopolies and the sector has experienced increased levels of competition and innovation. The traditional government-owned operators (most of which have now been privatised) are referred to as incumbents. The newer entrants are called alternative network providers or "altnets". Incumbents and altnets have constructed and own their network infrastructure. There are also service

2 2 of 10 8/15/2008 4:50 PM providers who do not own network infrastructure. These operators purchase capacity from either the incumbents or altnets and resell it to their customers. These service providers are generally referred to as resellers. b) Mobile or wireless sector. Mobile communications is a relatively new technology that has been embraced by users and has become an integral part of our environment and life-style. The main advantage of mobile or wireless communication is the user's mobility, since both the terminal (handset) used and access to the telecommunications network are independent of a fixed location. The term mobile communications refers to all communication networks that use radio-based technology. The major differentiation between a mobile network and a fixed-line network is the access network. A single fixed connection point at the customer's premises is necessary for access to the fixed-line network, whereas access to a mobile network is achieved through electromagnetic radiation within the network's area of coverage. The growth in the number of users of mobile communications has been significant over the last 15 years. Penetration levels have reached 70% in many countries. The mobile sector has also experienced dramatic technological developments in the last few years. The next generation (3G, i-mode, CDMA-2000) of mobile services is available in a number of countries, offering users a broader range of voice and data services over their mobile handsets. Resellers in the mobile sector are referred to as Mobile Virtual Network Operators or MVNOs. Intangible assets Operators continue to carry significant amounts of goodwill, telecom licences and other intangible assets on their balance sheets. Many of these intangible assets were acquired through business combinations in the 1990s. Internally-developed software Technological developments have made possible the introduction of new product and service offerings to customers. Many operators have spent time and money on the development and customisation of systems to deliver these innovative products. IFRS requires capitalisation of internal development costs is once feasibility is assured. Telecommunication licences The cost of mobile UMTS and other next generation licences represents one of the largest intangibles on operators' balance sheets. Amortisation of these licences should commence when they are "available for use". This will be the same date on which the underlying network assets become available for use. The recoverable amount of telecom licences not yet available for use should be reviewed annually for impairment. Telecom licences 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 [IAS38R.97].Telecom licences are underpinned by a legal agreement and stated term. The useful life of a telecom licence will generally be the period from when the licence becomes available for use through to the end of its remaining legal term. A history of renewals of telecom licences at insignificant cost might allow the useful life to extend beyond the contract term, but this would be unusual. Subscriber acquisition costs Many mobile operators connect subscribers for service through independent third party distributors or dealers. The dealers are paid a commission for each subscriber connected to the network. The commission amounts vary depending on the type of subscriber connected post-pay or pre-pay and the expected quality of the revenue stream associated with the subscriber contract. The costs of acquiring contracts which are identifiable, controlled by a company and meet the recognition criteria of IAS 38R should be capitalised as intangible assets. Initial recognition Identifiability and control a post-pay subscriber contract meets the identifiability criterion as it arises from contractual rights [IAS38R.12(b)] The existence of an enforceable legal contract underpins an operator s ability to control the future cash flows from its post-pay subscribers. Legal enforceability of a contract is not a necessary condition for control because the operator may be able to control future economic benefits in some other way [IAS38R.13]. However, in the absence of legal rights to protect, or other ways to control, the relationships with subscribers or the loyalty of the subscribers to the entity, the entity usually has insufficient control over the expected economic benefits from subscriber relationships and loyalty for such items to meet the definition of intangible assets [IAS38R.16]. Although pre-pay subscribers do not

3 3 of 10 8/15/2008 4:50 PM sign written contracts for service, the economic benefit from the initial sale has already accrued to the operator. Therefore, the costs of acquiring these subscribers will also normally meet the recognition criteria of IAS 38R. However, the amount of the initial card sale is usually small and the expected period over which the card is used is quite short. Subscriber acquisition costs associated with pre-pay customers would, in practice, be amortised over a very short period of time. Probability of future economic benefits the future economic benefits flowing from post-pay and pre-pay subscribers is the net cash flows from the provision of telecommunication services. Normally, the price an entity pays to acquire separately an intangible asset reflects expectations about the probability that the expected future economic benefits embodied in the asset will flow to the entity. Therefore, the probability recognition criterion is always considered to be satisfied for separately acquired intangible assets [IAS38R.25]. However, if the projected cash flows are less than the direct costs incurred, then the amount to be recognised as subscriber acquisition costs is limited to the net cash inflows expected from the customer. The operator must be able to demonstrate expected positive cash flows. Reliable measurement of cost the cost is the amount of the incremental costs that the operator has agreed to pay for the acquisition of the subscriber. Costs incurred in an operators own retail stores are not generally incremental on a subscriber connection basis, and therefore cannot usually be capitalised as an intangible asset, although if the costs are demonstrably incremental, then they may meet the criteria for recognition. Normally, the operator will be able to measure the incremental direct costs. However, sometimes it is difficult to assess whether an intangible asset qualifies for recognition because of problems in determining the cost of the asset reliably. In some cases, the cost of developing an intangible asset cannot be distinguished from the cost of maintaining or enhancing the entity's internally generated goodwill or of running day-to-day operations [IAS38R.49]. Where the operator is unable to reliably measure the extent to which costs relate directly to the acquisition of customers rather than to general sales and marketing efforts, it may be appropriate to expense all such costs as incurred. Amortisation of subscriber acquisition costs The depreciable amount of an intangible asset with a finite useful life is allocated on a systematic basis over its useful life [IAS38R.97]. Customer related intangible assets that arise from a contract shoul be amortised over the period of the contract. The amortisation period includes the renewal period(s) only if there is evidence to support renewal without significant cost [IAS38R.94]. However, the decision to renew is always made by the subscriber and the operator does not have control over the renewal decision. A longer period of amortisation based on the expected period of the overall customer relationship is, therefore, not appropriate. If the subscriber does renew, and the cost of renewal is significant when compared with the future economic benefits expected to flow to the entity from renewal, the ' renewal cost represents, in substance, the cost to acquire a new intangible asset at the renewal date [IAS38R.96]. Impairment of subscriber acquisition costs Customer related intangibles are carried at amortised cost less impairment. Each customer is separately acquired (other than in a business combination) and each related asset is individually assessed for impairment. The operator should have a system that triggers impairment testing in the event of non-payment or less than expected usage on a customer specific basis. Costs to be included in subscriber acquisition cost Operators incur a wide range of expenditures in order to secure new customers to their network. However, to meet the criteria for recognition as subscriber acquisition costs, the costs must be direct, incremental costs of acquiring (or retaining) subscribers on the network. In many cases, this will be restricted to the amounts paid to dealers (which may include handset subsidy) which are based on specific subscriber acquisition, although if an operator pays commissions to its own sales force for signing up customers this might meet the criteria. Increasingly, operators are moving away from paying one-off upfront commissions to dealers when customers are initially signed up, and developing schemes which incentivise the dealers to sign up high value customers to the network. These schemes include revenue share schemes, where the dealer is given an agreed percentage of the airtime revenues generated by the customer. The costs incurred under these types of arrangements are likely to meet the criteria for inclusion in subscriber acquisition costs, as they are direct, incremental costs. The commitment to make payments to dealers based on revenues generated by the customer (or other similar transactions) will often meet the criteria in IAS 32R for a financial liability and will be required to be recognised under IAS 39R at the inception of the customer contract. The amount recognised will be the fair value of the expected cash outflows to the dealers. Similar transactions include anniversary or renewal commission which are paid to dealers if the customer extends the contract at the end of the initial term.

4 4 of 10 8/15/2008 4:50 PM Property plant and equipment (PP&E) The costs of constructing a telecommunication network range from the cost of purchasing network equipment and fees paid to third party engineers to the internal costs of planning and financing the construction process. The phases of a telecommunications network's development fall into five stages: (i) licence bid and preliminary; (ii) network design and planning; (iii) acquisition and construction; (iv) commissioning (testing); and (v) post-launch (operating). Costs to acquire and install network equipment are capitalised according to the requirements of IAS 16R.7. This includes directly-attributable costs and certain costs incurred during the pre-operating stages that may be capitalised. Judgement is required in determining which network roll-out stage an operator is in, and what expenditure may be capitalised as part of the initial cost of constructing the network or is an operating cost. Some of the specific issues that may arise include: Solution 122.6, Capitalisation of rental expenses Solution 122.7, Capitalisation of network planning Solution 122.8, Capitalisation of site selection costs Most telecommunications networks are constructed on public land and operators do not typically acquire legal title to the land. The operators pay landowners for the right of access to inspect and maintain the network. The costs of dismantling network assets and restoring the land to its original condition should be capitalised as part of the initial cost of constructing the network. Network assets are depreciated from the date they become available for use. The "available for use" date is often equated to commercial launch. Commercial launch is not a rigidly-defined term but is usually interpreted as when the engineers' sign-off testing has been completed and the network is capable of providing commercial services. This is the date when depreciation should commence. There is little relationship between the usage of network assets (traffic carried) and the rate at which the network is consumed. Network assets should be depreciated on a straight-line basis from the date they became available for use. Indefeasible Rights of Use ("IRUs") and capacity arrangements Many operators enter into IRU and/or capacity arrangements to minimise the cost of constructing networks and to accelerate the rate of network roll-out. This area of telecom accounting received considerable scrutiny following challenges of "hollow swapping" (transactions lacking commercial substance, but structured to achieve an accounting result). US GAAP, for example, issued prescriptive guidance on the appropriate accounting treatment of IRUs and capacity arrangements. There is no specific guidance on accounting for IRUs under IFRS. The accounting treatment is determined by the agreement's commercial substance. This requires a careful review of each set of specific facts and circumstances. Characteristics and types of an IRU agreement There is no universally-accepted definition of an IRU. These agreements come in many forms. However, the key characteristics of a typical arrangement include: the right to use specified network infrastructure; for a specified term (often the majority of the useful life of the relevant assets); legal title is not transferred; a number of associated service agreements including Operations and Maintenance ("O&M") and co-location agreements. These are typically for the same term as the IRU; and any payments are made in advance. The main types of IRU and capacity agreements can be characterised as follows: 1) purchase or sale of specified network infrastructure;

5 5 of 10 8/15/2008 4:50 PM 2) purchase or sale of lit fibre capacity; and 3) exchange of network infrastructure or lit fibre capacity. Purchase of specified infrastructure Operators acquire or grant a right to use specifically identified network assets; for example, empty ducts or dark fibre pairs. The selling operator (the "seller") will have negotiated land access rights with the relevant landowners and is generally not permitted to assign these rights to the buying operator (the "buyer"). Hence the seller will generally supervise any initial cabling and ongoing maintenance that the buyer undertakes. The seller does not have any other ongoing involvement in the use of the network assets. The buyer determines the specification of the network, the nature of telecommunication services provided over the network assets and whether or not to use the assets. These agreements are akin to leases in that they convey a right to use specified network assets, to the exclusion of other operators, including the seller. Payment for the use of the assets is made in advance and does not vary with the buyer's actual usage. IRU arrangements that transfer substantially all of the risks and rewards of ownership to the buyer should be capitalised as PP&E. The ongoing involvement of the seller, for example through the supervision of access, needs to be assessed in determining where the risks and rewards of ownership rest. An IRU often contains multiple elements such as O&M and co-location agreements. Separate contracts may be executed for each element, with flows from the buyer to seller associated with each separate contract. The contracts must be considered together when determining cost of assets acquired and the costs that are operating expense. The relative fair value of each element of the arrangement should be determined and the same proportion of cost ( paid, discounted as appropriate) allocated to the element. The IRU assets should be capitalised based on their relative fair value. The costs of associated O&M and co-location services should also be recorded as their relative fair value as the costs are incurred. The seller's accounting should mirror the buyer's. Purchase of lit fibre capacity The seller grants a fixed-term right to use a specified amount of its network capacity, for example, STM-4s or OC-1s. The seller controls the routing of the buyer's traffic - that is, the network path from A to B is not fixed or dedicated to the buyer's use. The seller can determine which of its network assets (or those of other operators) terminates the buyer's traffic. The seller retains a high degree of responsibility and ongoing involvement in these arrangements. The buyer should record the cost of the lit capacity as a prepayment and recognise the cost of the right to use the capacity on a straight-line basis over the term of the agreement. The seller's accounting should mirror that of the buyer's. Exchange of network infrastructure or lit fibre capacity Telecom operators often exchange network assets or swap lit capacity. Operators may exchange payment at the same time, but the net impact of these arrangements is often neutral. An exchange of fixed assets with commercial substance is accounted for at fair value [IAS16R.24]. Commercial substance is determined by assessing if the entity's flows have changed after the transaction. An exchange of network assets without commercial substance is unusual. Any assets acquired in such an exchange are recorded at the carrying value of the network assets given up. Impairment of network assets and telecom licences There has been a significant downturn in the global economy in recent years and the telecommunication sector has been hard hit, with billions written off goodwill, telecom licences and network assets. Impairment indicators Operators must assess at each balance sheet date whether there is any indication that an asset is impaired [IAS36R.9]. External factors and evidence from internal reporting may provide indicators that an asset is impaired. Management should consider both general and telecom-specific factors, including: 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 (CPGA);

6 6 of 10 8/15/2008 4:50 PM network operating or maintenance expenditure significantly in excess of original budget; significant shortfall of revenues compared to budget or prior periods; technological developments that may reduce the economic performance of the licence (i.e. the technology related to the licence becomes obsolete); impact of changes in regulation and deregulation; and increases in market interest rates. Cash Generating Units An operator must determine if assets should be tested separately for impairment or as part of a cash generating unit (CGU). CGUs are the smallest group of assets, which include the asset under review, which generate cash inflows that are largely independent from other assets or groups of assets. The independence of cash flows will be indicated by the way management monitors the operator's activities, for example by product lines or locations. Operators need to consider if the network can be treated as a single CGU ; if fixed and mobile businesses can be a single CGU ; and if the 2G business is independent of the 3G business. Telecom licences in use do not generate independent cash flows and should be assessed for impairment together with the related network assets. Calculating a CGU's recoverable amount An asset's carrying value should not be greater than its recoverable amount, which is the higher of its value in use or fair value less costs to sell. The CGU's recoverable amount must be calculated and compared with its net book value. There have been few sales of businesses recently to provide market data on the fair value of a telecom business. Operators have assessed the recoverable amount of CGUs by relying on value in use. As the market picks up, operators should determine if there are market transactions to support fair value estimates. Forecast Horizon Value in use is the net present value of the future cash flows expected to be generated from the CGU. Cash flow projections should be based on reasonable and supportable assumptions that represent management's best estimate of the range of economic conditions that will exist over the assets' remaining useful lives or in the CGU [IAS36R.33]. The projections should be based on management's most recently approved financial budgets/forecasts and should not exceed a period of five years unless a longer period can be justified. The projections beyond this point should be extrapolated using a steady or declining growth rate. These projections should be extrapolated over the remaining useful life of the primary asset in the CGU. Capital expenditure Future cash flows are estimated for the CGU in its current condition [IAS 36R.44]. Estimates of future cash flows should not include amounts expected to arise from improving or enhancing the CGU's current performance. Most operators have significant capital expenditure programmes in place. Determining whether items of capital expenditure complete, maintain or enhance the network asset is often complex. Maintenance cash flows may be included in the value in use calculation [IAS38R.49]. Estimated cash outflows necessary to prepare an asset or CGU in the course of construction for use together with the expected cash inflows may also be included in the calculation of value in use. Future capital expenditure that extends the network's reach or enhances its performance may not be included. Fixed-line operators incur customer-specific capital cash flows in connecting customers to their existing network. These costs are akin to customer acquisition costs, albeit they meet the capitalisation criteria of IAS 16 (revised). This expenditure and the forecast incremental revenues may be included in the calculation of recoverable amount. Inventories There is an established practice of operators selling handsets to customers at a significant discount. Indeed in many countries handsets are given free of charge to customers who sign a service contract (post-pay). Subsidies and discounts are also given to pre-pay customers. Inventory is carried at the lower of cost and net realisable value [IAS2R.9]. Inventory should be written down to management's best estimate of the net realisable value at the point a loss on the sale of the inventory is committed.

7 7 of 10 8/15/2008 4:50 PM Operators should write down inventories of handsets to their net realisable value at the balance sheet date. If the operator cannot determine the net realisable value for specific consignments of handsets, then a best estimate should be made, based on the operator's historic evidence of the level of handsets connected to post-pay tariffs. Revenue recognition Operators' distribution and retail activities were traditionally straightforward. The fixed-line and 2G operators provided voice service and levied a charge on a per minute basis. Revenue was recognised as the service was provided by the operator. Today, revenue recognition is one of the most complex accounting issues the industry faces. Deregulation, innovation and competition have driven complexity in the industry. It has changed the way the various players contract with each other to deliver service; for example, content providers and service providers. Change has also driven complexity in the service offerings to customers, in particular for bundled (or multiple-element) arrangements that may include a handset set. Discounts and rebates It is usual for operators to subsidise telecom equipment and discount services. Revenue should be recorded net of any discounts, subsidies or rebates to customers, or resellers of the operator's equipment and services. Service arrangements The majority of operators' revenues are earned from the provision of telecommunication services to attract customers. Revenue should be recognised as the service is rendered - that is, as the operator fulfils its obligations to the customer. Most fixed-line and mobile operators sell prepaid call cards. Customers pay for the card in advance and are entitled to a particular number of minutes over a period of time. The operators are not earning revenue from the sale of the physical card. Revenue is earned from the subsequent provision of telecommunication services. The advance payments received should be recorded as deferred revenue. Revenue should be recognised as the services are rendered - that is, as the customer uses the credit or on expiry of the card. Operators sell prepaid cards without a stated expiry date in some territories. An unused amount, often small, can remain on the cards indefinitely. Revenue is only recognised on the cards as the services are used. If there is no expiry date on the card the operator never extinguishes its responsibility to deliver service. The revenue relating to the unused minutes should not be recognised, even where the operator is able to demonstrate that it is unlikely that the card will be used again. Principal/agent arrangements Convergence has been a "buzz word" in the telecom industry for some time, with operators seeking to deliver more services and content through the handset to the consumer. Operators are increasingly entering into alliances and revenue share arrangements with third parties for content and other services. Determining if the operator is principal or agent depends on the facts of each arrangement. A principal should record revenue as the gross proceeds billed, net of any discounts and sales taxes. An agent should record revenue as the net commission earned [IAS18R.8]. It can sometimes be difficult to determine whether an entity is functioning as an agent or as a principal. The standard does not provide any prescriptive guidance on the determination. Typically, a principal has: the contractual relationship with the customer; that is, the customer believes he is doing business with the principal (e.g. the customer looks to the principal for "customer satisfaction" issues, such as warranty claims beyond those provided by a third party manufacturer and product returns); the ability to set the terms of the transactions (e.g. selling price, payment terms etc). inventory risk (e.g. loss in value of handset); credit risk (if the customer defaults, the principal bears the loss);and responsibility for the collection and remission of any sales or similar tax that is imposed on the transaction. The existence of any one of these conditions is not sufficient evidence that an operator is acting as a principal. Operators must consider all of the conditions above when concluding which accounting treatment to use for principal/agency arrangements.

8 8 of 10 8/15/2008 4:50 PM There are a large number of principal/agency relationships in the telecom industry. These often take the form of revenue share arrangements. The most common examples of principal/agency agreements in the industry are inter-operator interconnect and roaming arrangements. Operators are normally acting as principals in the provision of interconnect and roaming arrangements. However, in some countries special tripartite agreements are commonplace and operators act an agents on behalf of each other. Distribution arrangements with third party dealers Another area where the principal / agency relationship must be assessed is when operators sell equipment through third party dealers. A common example is the sale of mobile handsets through a dealer s stores. The assessment of whether a dealer is acting as a principal or agent will impact recognition and measurement of revenue. Where the circumstances of the relationship between the operator and the dealer demonstrate that the dealer is acting as a principal for the sale of handsets the operator should recognise the sale of the handset as a transaction separate from the subsequent acquisition of a customer via that dealer. The cost of the handset should be recognised as a cost of sale at the same time as revenue is recognised. The substance of the relationship between the operator and the dealer may be that the dealer is acting as an agent for the sale of handsets. The operator should not recognise revenue on any amounts received from the dealer on the initial sale of the handset to the dealer. The sale of the handset is recognised when it is sold to a customer and the customer is connected to the network. The operator must assess if the handset sale is a separate transaction which qualifies for immediate recognition, or whether it is linked to the provision of service (Multiple element arrangements - Identification of deliverables that qualify as separate elements. Multiple element arrangements The telecom industry is increasingly characterised by the offering of complex bundles as part of a single transaction or a series of linked transactions. Examples include the sale of broadband modems, connection and service in the fixed line sector and the sale of mobile handsets and service contracts in the mobile sector. These arrangements are referred to here as multiple-element arrangements ( MEAs ). Characteristics of MEAs MEAs require an operator to deliver telecom equipment and/or a number of services under one agreement, or under a series of agreements which are commercially linked. The package price of the goods or services is generally set below the price at which these items would be sold individually. Accounting for MEAs There are three factors which should be considered in determining the accounting for bundled or linked transactions [IAS18.13]. These are: 1. Is the commercial effect of the arrangement such that the deliverables should be accounted for separately? 2. If the deliverables are separable, how should the total consideration be allocated across the deliverables? and 3. When should revenue be recognised in respect of each deliverable? The questions raised in 1 and 2 above are considered below. The revenue recognition criteria of IAS 18 should be applied in respect of the sale of telecom equipment and the provision of services. Separation and linking of contractual arrangements A MEA should be accounted for as two or more separate transactions ( unbundled ) where the commercial substance is that the individual deliverables operate independently of each other. This means that each deliverable represents a separable good or service that the operator or another supplier routinely provides to customers on a stand alone basis. The operator should be able to attribute a reliable fair value to each deliverable by reference to transactions for that item alone, where the various deliverables are to be unbundled. The absence of a reliable fair value for any of the deliverables indicates that the goods and services do not operate independently. A reliable fair value is not established by a single transaction. A reliable fair value is established by the operator having a regular practice of selling the good or providing the service to customers. A reliable fair value may also be provided by another operator or retailer publishing prices for the good or service separately. Identification of deliverables that qualify as separate elements

9 9 of 10 8/15/2008 4:50 PM Telecom equipment and service Telecom equipment typically operates independently from the services provided. Operators sell services separately from handsets and vice versa. Subscribers can also purchase internet modems from retailers and obtain internet access from their telecom service provider. The latest models of 3G handsets can generally deliver 2G (voice and SMS) services on a 2G network. The sale of the handset or other equipment is not separable from the sale of the service where the service cannot be obtained independently from the purchase of the telecom equipment. The operator will need to consider whether the arrangement is only one service contract for which revenue should be spread over the life of the service or whether the arrangement it has with the customer is in substance a contract for service and a lease arrangement over the equipment in accordance with IFRIC 4 Determining whether an Arrangement contains a Lease. Connection Many fixed line and mobile service offerings include a charge for connection. Frequently, it will not be possible to demonstrate that the connection fee is in respect of a service which is operating independently from the service arrangement with the operator. There are circumstances where it will be possible for the operator to demonstrate that the connection is operating independently from the other services. This could be the case in a deregulated fixed line environment, where one operator provides the connection and another operator provides the service. Promotional offers It is common practice to offer free products to subscribers to encourage them to sign up to a contract; common free products have included DVDs or other electrical goods. These promotional offers are not separable revenue generating deliverables for the operator. All the revenue under the contract is revenue for the provision of telecommunications services and equipment. Operators should recognise the cost of these free products as a marketing expense. No revenue should be allocated to these services. Complex tariffs It is common practice for the service offering to subscribers to include a number of different elements voice, MMS, SMS content downloads on one tariff. The significance which is attached by analysts to the different elements in the results of operators means that the allocation of total consideration across the different elements is important. Allocation of total consideration received or receivable Revenue in a multiple element arrangement is recognised at the fair value of the consideration received or receivable in respect of each separable element. The recognition criteria in IAS 18 are usually applied separately to each transaction. However, in certain circumstances, it is necessary to apply the recognition criteria to the separately identifiable components of a single transaction in order to reflect the substance of the transaction. Conversely, the recognition criteria are applied to two or more transactions together when they are linked in such a way that the commercial effect cannot be understood without reference to the series of transactions as a whole [IAS18.13]. IAS 18 does not offer any practical guidance on how this principle should be applied in practice, particularly in light of the fact that the consideration received for the bundle is often less than the sum of the value of the individual elements. As revenue should be recognised at the fair value of the consideration received, the discount that the customer obtains by buying all the components should be applied rateably based on available fair values. Operators often offer significant discounts on the equipment. Therefore, the subscriber only pays a small amount at the time of sale in comparison to the value of the equipment received. An allocation of the total consideration of a MEA determined according to the relative fair value of the equipment and service may result in a larger amount of consideration being allocated to the equipment. The cost of the equipment is recognised at the same time as the related revenue. IRUs and capacity arrangements Accounting for the purchase and sale of IRUs and capacity arrangements is considered in the section 'Indefeasible Rights of Use ("IRUs") and capacity arrangements' above. The sellers accounting for the sale of specified network infrastructure and the sale of lit capacity should mirror that of the buyer. The exchange of lit network capacity that is similar in nature and value does not give rise to the recognition of revenue.