International accounting requirements keep staff at Deutsche Telekom's Finance department on their toes. The hottest topic at present is the new IFRS regulations on revenue recognition. This is not surprising, because telcos are among the companies most affected by the new requirements.
Helmut Becker, Head of General Accounting, Deutsche Telekom Services Europe, and Michael Brücks, Head of Principles, Policies & Research, Deutsche Telekom, explain in the interview which consequences the new rules will have for Deutsche Telekom.
Mr. Brücks, why is a new accounting standard necessary?
Michael Brücks: There is currently a wide variety of requirements and interpretations for recognition of revenue at an international level. This has given companies enormous discretion in terms of the timing and New regulations for our primary key indicator amount of revenue to be recognized, which makes it difficult for analysts and investors to make a reliable assessment of a company's financial situation. The existing regulations will now be consolidated in a new accounting standard, IFRS 15, with new requirements being added. This will enhance the comparability of the revenue figures disclosed by different companies and industries. The new standard will enter into force on January 1, 2018.
Why are telecommunications companies among the most affected by the new rules?
Michael Brücks: There are two reasons. Firstly, these companies serve the mass market with many millions of individualized contracts which in turn comprise a bundle of different communications services. These are known as multiple-element arrangements. A combination of a cell phone with a service contract is one such example. Secondly, in many cases the mobile handset is subsidized to a greater or lesser degree--this is another characteristic of the business model.
What will change for Deutsche Telekom as of January 1, 2018?
Michael Brücks: The challenge relates to how the total revenue will be divided among the elements of the mobile contract (cell phone and monthly service fee) based on the ratio of the stand-alone selling prices. The stand-alone selling price is the price at which the company would sell the product or service on a separate basis. Even though the mobile handset is subsidized within the framework of a contract, a not inconsiderable portion of total revenue must be allocated to the device. This is clearly shown by the numerical example.
If, in addition, our customers add or cancel discounted services in ongoing contracts, the ratio of the individual services to one another must be recalculated and accounted for every time this happens. The more diverse the contractual relationship is, the more complex it becomes to account for revenues. What is more, there is a time lag between revenue recognition and billing, so in the future it will no longer be possible to calculate revenue from the information stored in the existing IT systems.
Mr. Becker, is it already possible for you to estimate how IFRS 15 will affect the figures?
Helmut Becker: The standard gives us an option for simplified initial application - and we will make use of it. What this means is that the customer contracts that have not yet been completely fulfilled as of January 1, 2018 will be accounted for as if they had been recognized in accordance with IFRS 15 from the very beginning. This will increase our total assets. Furthermore, we anticipate a positive one-time effect in shareholders' equity (retained earnings) in the 2018 opening balance sheet. This effect will arise because, as a result of the transition, revenues for terminal equipment will be brought forward and customer acquisition costs will be capitalized. In subsequent years, both of these effects will be reversed through profit or loss over the remaining term of the contracts or the average customer retention period. On the other hand, from 2018 onwards there will also be positive effects from new contracts signed and other capitalized customer acquisition costs. In addition, mobile service revenues will decrease in the future, whereas hardware revenues will rise.
Accounting aside, what impact will IFRS 15 have on other areas?
Helmut Becker: Given the change in revenue figures, the new standard will naturally impact on our capital market and media communications. When announcing the business figures for the first half of 2017, we published quantitative statements for the first time based on management's current estimates. The new New regulations for our primary key indicator standard will also have an effect on controlling and corporate management at Deutsche Telekom. However, the new rules could affect incentive models as well.
What stage are you at as regards introducing the new standard?
Helmut Becker: We introduced the new regulations in Europe with the help of colleagues from OTE/Cosmote and Telekom IT. A total of twelve international Group companies were involved that collaborated extremely well for more than two years. Together we made adjustments to all the necessary processes and IT systems. This created the framework for us to be able to implement the new requirements successfully. In the coming months we will concentrate on tweaking the last remaining details.
Numerical example IFRS 15
Deutsche Telekom sells a contract comprising two elements: a cell phone New regulations for our primary key indicator and a monthly service fee. The customer pays a total of EUR 70 per month (EUR 1,680 over 24 months) for the service and EUR 100 for the telephone. Total EUR 1,780.
In the past, revenue of EUR 100 was recognized for the handset on the date the contract was signed. In addition, the company disclosed monthly service revenue of EUR 70.
In the future, the revenue will be determined based on the relative stand-alone selling prices. If the customer were to buy the services separately, the cell phone would presumably cost EUR 720 and the monthly service EUR 45, bringing the total to be paid over the minimum contract term to EUR 1,800. Of this amount, the handset would account for 40% and the service for 60%. IFRS 15 sets out that the actual total revenue of EUR 1,780 must be allocated in this ratio. For the mobile device, EUR 712 would therefore have to be recognized as revenue on the contract signing date. In the past, this was EUR 100. The remaining EUR 1,068 will be recognized as service revenues over a 24-month period, a sum of EUR 44.50 (instead of EUR 70) per month.
