Telstra Corporation Limited – Annual report – 30 June 2018
7.1.3 New accounting standards to be applied in future reporting periods (extract)
(b) Revenue from contracts with customers
In December 2014, the AASB issued AASB 15: ‘Revenue from Contracts with Customers’ and AASB 2014-5: ‘Amendments to Australian Accounting Standards arising from AASB 15’. In October 2015 the AASB issued AASB 2015-8: ‘Amendments to Australian Accounting Standards – Effective Date of AASB 15’ which deferred the effective date of the new revenue standard from 1 January 2017 to 1 January 2018. In May 2016, the AASB issued AASB 2016-3: ‘Amendments to Australian Accounting Standards – Clarifications to AASB 15.’ All these standards apply to Telstra from 1 July 2018 and are further collectively referred to as AASB 15.
AASB 15 supersedes the existing accounting standards and interpretations for revenue. It establishes principles for reporting the nature, amount, timing and uncertainty of revenue and cash flows arising from an entity’s contracts with customers and requires revenue to be recognised in a manner that depicts the transfer of promised goods or services to a customer and at an amount that reflects the consideration expected to be received in exchange for transferring those goods or services. This is achieved by applying the following five steps:
- identify the contract with the customer
- identify the performance obligations in the contract
- determine the transaction price
- allocate the transaction price to the performance obligations in the contract based on their standalone selling prices
- recognise revenue when (or as) performance obligations are satisfied.
AASB 15 also provides guidance relating to the treatment of contract costs, which are not in scope of other accounting standards, i.e. incremental costs of obtaining a contract and costs to fulfil the contract.
The application of AASB 15 will not affect our cash flows from operations or the methods and underlying economics through which we transact with our customers.
We have substantially completed our analysis and the impact assessment of the new revenue standard on our financial results, including changes to our accounting policies, internal and external reporting requirements, IT systems, business processes and associated internal controls in order to support ongoing compliance with the new accounting requirements from 1 July 2018 i.e. the mandatory effective date. However, we will continue to fully embed the new requirement into our processes in the financial year 2019. We will apply the standard retrospectively to prior reporting periods from 1 July 2017.
Like many other telecommunications companies we have identified that the adoption of the new revenue standard will result in a number of accounting policy changes and a financial impact on our opening retained earnings (as at 1 July 2017) and on restatement of the financial performance for 2018. Impacts identified primarily relate to the timing of revenue recognition, the classification of revenue, the capitalisation of costs to obtain a contract with a customer and expensing some of the currently deferred costs to fulfil a contract. These changes are summarised below together with the most reliable estimates of the expected financial impacts. Those estimates may be subject to some changes as we progress to fully operationalise the new requirements in the financial year 2019. Our final adjustments and detailed disclosures will be included in our financial year 2019 financial statements.
(i) Our contracts with customers
We generate revenue from customer contracts, which vary in their form (standard or bespoke), legal term (casual, short-term or long-term) and customer segment (consumer, small to medium business and government and large enterprise). AASB 15 impacts will differ depending on the type of customer contract, with the main contracts being:
- homogeneous retail consumer contracts (mass market prepaid and postpaid mobile, fixed and media offerings)
- retail small to medium business contracts (mass market and off-the shelf technology solutions)
- retail enterprise and government contracts (carriage, standardised and bespoke technology solutions and their management)
- network capacity contracts (mainly Indefeasible Right of Use)
- wholesale contracts for telecommunication services
- nbn Definitive Agreements (nbn DAs)
- network design, build and maintenance contracts (mainly with nbn co).
A summary of the changes in our accounting policies on the adoption of AASB 15 is presented below.
(ii) Identifying customer contracts, their combinations and modifications
AASB 15 focuses on legal rights and obligations included in a contract (which may be a contract that AASB 15 requires to be combined with another contract) when determining the contract level and its term for accounting purposes. AASB 15 guidance also assumes that the contract will not be cancelled, renewed or modified. Establishing the contract term for accounting purposes impacts determination of performance obligations and the transaction price to be allocated to goods and services. Therefore, timing and amount of revenue recognised may be impacted.
Our mobile long-term contracts often offer a bundle of hardware (delivered upfront) and services (delivered over the contract term), where the customer pays a monthly fee and receives a discount, which is allocated between the hardware and services based on their relative selling prices. When determining the customer contract, AASB 15 requires us to assess the combination of two or more contracts entered into at or near the same time with the same customer. As a result, we will change the accounting treatment of customer contracts sold via our dealer channel, where the currently applied substance over form principle will be overridden by the new contract combination rules. This will preclude us from combining separate legal contracts, i.e. with the dealer for hardware and the customer for services. Consequently, no discounts will be allocated to hardware sold via dealer channel, which will result in a higher hardware revenue at the time of its recognition and lower services revenue over the customer contract term.
Our nbn DAs include a number of separate legal contracts with both nbn co and the Commonwealth Government (being related parties hence treated as the same customer) which have been negotiated together with a common commercial objective. The nbn DAs were originally signed in 2011 and subsequently modified in 2014 and 2015. These separate legal contracts have been combined under the AASB 15 assessment. However, the combined nbn DAs include a number of out of scope elements. This includes Telstra Universal Service Obligation Performance Agreement and the Retraining Deed, which have both been separately priced and will continue to be accounted for as government grants. The Subscriber Agreement will also continue to be separately accounted for as other income given the nbn disconnection fees do not relate to our ordinary activities and there is no price dependency with other nbn DAs. On the other hand, the additional payment received under the Information Campaign and Migration (ICM) Deed for the build of nbn related infrastructure, will now be combined and accounted for together with the Infrastructure Services Agreement (ISA). ISA also includes payments for sale of our infrastructure assets, which are not in scope of AASB 15, however, the timing of control transfer over these assets and the amount of consideration to be included in the net gain on their disposal will be calculated by reference to the AASB 15 principles. The combined contract has a minimum fixed term for accounting purposes of 30 years.
When determining the contract term for accounting purposes AASB 15 focuses on legal rights and obligations of counterparties to the agreement. Currently our accounting is largely aligned to the legal term of the contacts. On adoption of the AASB 15 the contract term for accounting purposes will change mainly for our enterprise and government contracts, our wholesale contracts and commercial contracts with nbn co. These types of contracts often include general terms and conditions (including pricing) under which customers can order goods and services in the future, i.e. they are framework / umbrella agreements rather than accounting contracts. This is because on signing of the framework agreement the customer would not have committed to purchase any goods or services; rather goods or services will only be transferred to the customer once a valid purchase order or a statement of work is raised. Furthermore, where the goods or services have been identified the term of legal contracts may need to be reduced if the termination of the contract would not result in a substantive penalty to the customer over and above the amounts owed by the customer for goods and services already delivered (i.e. where the contract can be cancelled by either party at any time). In such circumstances additional good or services requested by the customer under the same order will often be treated and accounted for as separate short-term accounting contracts.
AASB 15 gives far greater detail on how to account for contract modifications than the current revenue accounting principles. Changes must be accounted for either as a retrospective cumulative change to revenue (creating either a catch up or deferral of past revenues for all performance obligations in the original contract), a prospective change to revenue with a reallocation of revenues amongst remaining performance obligations in the original contract, as a separate contract which will not require any reallocation to performance obligations in the original contract, or both a cumulative change and prospective change to revenue in the original contract.
Currently we account for any changes in our retail mass market contracts prospectively. Upon transition to AASB 15, we do not expect material impacts from modifications of these contracts because the standard terms and conditions of our homogeneous mass market contracts are normally not re-negotiated and the customer rights to move up and down within the plan family are included in each contract from its inception and considered to be a non-beneficial option.
However, our bespoke contracts with small business, enterprise and wholesale customers are varied or re-negotiated from time to time. Currently each time we consider specific facts and circumstances and, depending on the nature and legal form of the negotiated changes, we determine the appropriate accounting treatment using the existing accounting principles. On transition to AASB 15 we expect our bespoke contracts to be impacted by the new rules which will apply to any contract re-negotiations from financial year 2018 onwards. This is because we have elected to apply a transition practical expedient for contracts that were modified before 1 July 2017, i.e. we will not retrospectively restate the transitioning contracts for each of their modifications. Instead, we will reflect the aggregate effect of all of the modifications that have occurred before 1 July 2017 when estimating the retained earnings adjustments. For the restatement of the financial year 2018 we have not identified material adjustments arising from contract modifications of our bespoke contracts.
(iii) Identifying performance obligations
AASB 15 provides guidance on determining if goods or services are distinct and therefore if revenue should be allocated and recognised when these goods have been delivered or the services performed (i.e. when the customer controls them). The new guidance will result in some changes to our current accounting policy of identifying deliverables which have value to the customer on standalone basis.
Under some of our enterprise and wholesale arrangements we receive customer and developer contributions to extend, relocate or amend our network assets to ultimately enable delivery of telecommunication services to end users. The contributed network assets (or cash for network construction activities) are currently recognised as sales revenue over the period of the network construction activities if they are a separate deliverable under Interpretation 18: ‘Transfer of Assets from Customers’. Interpretation 18 is superseded by AASB 15 and we have identified changes to current accounting for these type of arrangements.
Depending on whether ongoing telecommunication services are also purchased under the same arrangement will determine whether these contracts are in scope of AASB 15. This is because Telstra continues to control the contributed network assets (i.e. they will never transfer to the counterparty) and therefore on their own they cannot be a performance obligation to which sales revenue from these arrangements can be allocated.
Where the counterparty makes a contribution for network construction activities and under the same (or linked) contract(s) purchases ongoing services the arrangement represents a contract with a customer, as the customer purchases goods or services, and therefore it is in scope of AASB 15. As the contributed network assets cannot be a performance obligation to the customer as these are our assets, the upfront contribution should be added to a total transaction price of the customer contract and allocated to the distinct goods and services to be delivered under that contract. Compared to current accounting this will result in a deferral of sales revenue due to the long term nature of these contracts.
However, where under the same (or linked) contract(s) the counterparty does not purchase any ongoing services, the arrangement is not in scope of AASB 15 because the counterparty is not transacting to purchase any goods or services, i.e. is not considered to be a customer under AASB 15. These kind of arrangements are not covered by any specific accounting guidance. Therefore we will continue to account for them consistent with the current accounting treatment under an internally developed accounting policy based on the ‘Framework for the Preparation and Presentation of Financial Statements’.
Another change to current accounting will result from AASB 15 defining a material right, which constitutes a separate performance obligation in a customer contract and gives the customer an option to acquire additional goods or services at a discount or for free i.e. it is beneficial. In principle this concept is largely consistent with our current accounting policy for non-cash sales incentives which are treated as separate deliverables. However, determination and measurement of material rights (including accounting for their breakage) will differ from our current practice. As a result revenue will be allocated to some of the goods and services we currently offer for free in our mass market plans or as part of the small business and enterprise loyalty programs and technology funds, but given the value of material rights is usually not significant compared to the total contract value we have not identified material adjustments for those items on transition to AASB 15.
Finally, in our nbn DAs the build of nbn related infrastructure under the ICM Deed will not be considered a separate performance obligation because the constructed infrastructure is an asset owned and controlled by us. As a result, on transition to AASB 15 the payment received, for which revenue had already been recognised between the financial years 2012 and 2014, will instead be treated as an advance receipt for performance obligations transferred over the ISA average contracted period of 35 years, leading to an opening retained earnings adjustment on transition of our nbn DAs.
(iv) Determining and allocating the transaction price
AASB 15 removes our contingent consideration accounting policy. Currently in the arrangements with multiple deliverables we limit revenue to the amount that is not contingent upon the delivery of additional items or meeting other specified performance conditions (non-contingent amount). Because our mobile long-term mass market contracts which offer a bundle of hardware and services comprise of two legal contracts and under the terms of these contracts the allocated hardware amount is not contingent on delivery of future services, we currently recognise the hardware revenue on delivery of the handset. Therefore, on adoption of AASB 15, and unlike many other telecommunication companies, we have not identified an acceleration of hardware revenue in our mobiles business due to the removal of the contingent consideration rules. Also we have not identified material adjustments to small business, enterprise or wholesale contracts as generally they have not been impacted by the contingent consideration rules.
In some of our mass market contracts the amount of consideration can vary because of a price concession offered when a customer agrees to an early upgrade of their contract, which constitute variable consideration under AASB 15. AASB 15 defines variable consideration wider than our current accounting policy and provides guidance on estimating and constraining it, limiting revenue recognition to the amounts which are highly probable not be reversed when the uncertainty related to the variable consideration is resolved. However, we have not identified material adjustments related to accounting for variable consideration in those contracts on transition to AASB 15.
Our contracts offer customers the ability to move up and down within the plan family under predefined terms. As a result, often we can only contractually enforce a lower amount than the monthly fee customer has initially signed up for. In situations such as these, we should allocate revenue between performance obligations using the minimum enforceable rights and obligations and any excess amount should be recognized as revenue as it is earned. However, due to low level of plan changes we have not identified material adjustments resulting from this accounting change on transition to AASB 15.
If a customer receives any discounts when purchasing a bundle of goods or services under one accounting contract, AASB 15 requires a proportional allocation of the discounts to all performance obligations, unless the exception allocation criteria are met, in which case the discounts can be allocated to only one or some but not all performance obligations. This differs from our current accounting policy which allocates cash sales incentives to goods or services contributing towards the earning of the incentives. Meeting the allocation exemption criteria is expected to be rare. On transition to AASB 15 we have identified some changes in timing of revenue recognition and product allocations in our mobile and fixed mass market contracts and product allocations in our wholesale contracts.
AASB 15 also provides new guidance on how to determine standalone selling prices, by reference to which the total transaction price gets allocated to goods and services. Despite the fact that our current accounting policy uses relative selling prices as allocation basis, i.e. a concept similar to standalone selling prices, AASB 15 requires consideration of similar customer circumstances, including for example assessment of volumes they are expected to purchase. As a result, we have identified an adjustment to our mass market mobile contracts where a higher hardware revenue will be recognised at the time of its recognition, and lower services revenue over the customer contract term as well as revenue allocation between the products in a bundle will change.
For our bespoke contracts no material impacts on transition to AASB 15 have been identified because in general, negotiated prices are aligned with the standalone selling prices of distinct goods and services promised under the contract.
Under some of our mass market contracts customers obtain a handset or another device on a device repayment plan, i.e. under deferred payment terms. Under AASB 15 Telstra is considered to provide financing to the customer. AASB 15 requires us to separately account for a significant financing component and measure it at contract inception using a discount rate that would be used in a separate financing transaction between Telstra and the customer. This rate would reflect the credit characteristics of the party receiving the financing in the contract, i.e. the customer. For our mass market customers this rate is significantly higher than our current practice of using Telstra’s incremental borrowing rate. This change will result in a reduction of revenue and a higher interest income being recognised over the contract term.
AASB 15 also introduces accounting for a significant financing element for arrangements where customers pay for goods or services in advance of receiving them (i.e. Telstra receives financing from the customer). In those circumstances revenue recognised will exceed the cash payments received in advance of performance as interest expense will be recorded. This change will impact accounting for some of our domestic and international bespoke network capacity agreements, i.e. Indefeasible Right of Use which include an upfront prepayment and have an average legal contract term between 10 and 33 years.
AASB 15 requires accounting for a financing component only if it is assessed as significant in the context of a contract as a whole. As a result, we will cease to account for the financing component in our nbn DAs because financing is not considered to be significant in these agreements.
AASB 15 defines a concept of a sale with a right of return and provides clear guidance for accounting for refund liabilities and recognition of the products expected to be returned. We have not identified material impacts for this change but some of our contracts include the right of return and their revenue recognition, measurement and presentation on the balance sheet will be impacted.
(v) Contract costs
AASB 15 provides accounting guidance for incremental costs of obtaining a contract and costs to fulfil a contract. Currently we account for these costs under our internal policy based on the Interpretation 1042: ‘Subscriber Acquisition Costs in the Telecommunications Industry’, which is superseded by AASB 15. Contract costs which meet AASB 15 capitalisation criteria must be amortised on a basis consistent with the transfer of goods and services to which these costs relate to under an existing and an anticipated customer contract(s) (if for example the customer can renew the contract for the same or subset of same goods and services).
Under current accounting, incremental costs to obtain a contract, such as directly attributable sales commissions, are capitalised in deferred expenditure and amortised on a straight line basis over the average customer contract term. Under AASB 15 we have identified a net increase in these capitalised costs, due to a combination of factors. We have substantially extended the amortisation periods for sales commissions paid on acquisition of the initial contract where these commissions are not commensurate with recontracting commissions. Therefore, the amortisation period for the initial commissions reflects the expected customer life rather than just an initial contract term. This impact has been partly offset by adjustments for early terminated contracts and commissions related to short term contracts (i.e. one year or less) which have been expensed as incurred under the practical expedient allowed by AASB 15. Under AASB 15, these costs will also be presented in the statement of financial position as contract costs instead of intangible assets.
We have identified impacts in relation to costs to fulfil a contract. On adoption of AASB 15 we will expense two major classes of deferred expenses, which are currently included in our intangible assets. These are costs associated with connection and activation activities related to our fixed network contracts and remediation costs related to our nbn DAs. These costs arise from work performed on Telstra owned assets and therefore are not in scope of AASB 15 as they are already assessed under AASB 116: ‘Property, plant and equipment’. We will continue to capitalise and amortise over the contract term certain set up costs that relate to our large enterprise contracts, however these costs will be presented in the statement of financial position as contract costs instead of intangible assets.
Our deferred expenses currently also include certain balances related to cash and non-cash sales incentives which have been granted mainly to our small business, enterprise and wholesale customers at contract inception. Under current accounting, both types of incentives reduce sales revenue over the term of the customer contract on a straight line basis and either result in an upfront reduction of receivables or cash (for cash sales incentives) or the recognition of other liabilities (for non-cash sales incentives considered to be separate deliverables) to reflect our obligation to deliver additional goods or services. Under AASB 15 these amounts either represent a discount that should reduce the transaction price (if the incentive is cash) or a material right for additional goods or services (if the incentive is non-cash), which represents a separate performance obligation in the customer contract.
Given our current accounting largely aligns with the new requirements, no material re-measurement adjustments have been identified for these types of deferred expenses. However, they will be presented as part of a contract asset or contract liability under AASB 15.
(vi) Presentation and classification
AASB 15 requires changes to presentation and classification of items in the statement of financial position and in the income statement. This includes presentation in the statement of financial position of a contract asset or contract liability at the contract level, separate presentation of contract costs and appropriate current and non-current split of all relevant balance sheet line items. On adoption of AASB 15 a number of existing line items in the statement of financial position (e.g. accrued revenue and revenue received in advance) will be replaced by the new presentation of contract assets and liabilities and new items will be created (e.g. refund liabilities). AASB 15 also requires disclosure of disaggregated revenue. We will provide detailed disclosures for the financial year 2018 on its restatement in our financial statements for the financial year 2019.
(vii) Expected financial impact on the first time adoption in financial year 2019
On adoption of the new standard in the financial year ending 30 June 2019, we expect the following adjustments to be made to our financial statements for the financial year 2019 to reflect the requirements of AASB 15:
- $516 million decrease ($412 million after tax) in opening retained earnings as at 1 July 2017 with corresponding adjustments against relevant line items in the statement of financial position;
- $191 million decrease in total income, $300 million decrease in operating expenses, $109 million increase in EBITDA, $39 million increase in net finance costs, $70 million increase in profit before tax and $51 million increase in our net profit after tax for the year ended 30 June 2018.
We expect the above estimates to be consistent with the full restatement of the financial year 2018 (i.e. comparative period) results in our 30 June 2019 financial statements. However, we are yet to fully operationalise the AASB 15 requirements across all parts of our business and should we identify any other changes or adjust current estimates we will update the above estimates to reflect our final adjustments in the financial year 2019 financial statements.