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Acquisition

Answer – 1 (a) 

Management of Telstra has the practice of identifying all profit earning segments as Cash Generating Units (CGUs), Telstra, (2016). With the commencement of the revised NBN Definitive Agreements (NBN DAs), the company is going to transfer the Hybrid Fibre Coaxial (HFC) cable network, which was functioning as a separate CGU for impairment assessment, to the assets of NBN Co. The transfer will include assets such as Lead-in Conduits (LICs), HFC and certain other external infrastructure assets associated with this CGU. The management has acknowledged that after the revised NBN Das coming into force, it is not possible to separate the cash inflows jointly generated by both the networks, as per Baker & Riddick, (2013). 

This is also in conformation with the Australian Conceptual Framework which prescribes AASB 101, the standard which prescribes the following segments to be reported cohesively.

Acquisition

Property, Plant and Equipment are to be recorded at cost price less the accumulated depreciation and impairment. Telstra capitalises all borrowing costs, attributing them directly to an acquisition of a qualifying asset. Telstra then recognises as expense all other borrowing costs in its income statement, assert Greuning, Scott & Terblanche, (2011).

Depreciation

All items of Property, Plant and Equipment are depreciated by Telstra on a straight-line basis over their estimated useful lives, Telstra, (2016). Depreciation of assets starts after their installation. The useful lives of the Property, Plant and Equipment assets are shown in Table B, as per Janousek et al, (2015). 

Answer – 1 (b) 

Telstra transferred its assets valued at $1,004 million, as explained above, to NBN Co. under the revised NBN DAs as at 30 June 2016. This was 4.9 per cent of Telstra’s Net Book Value of its total Property, Plant and Equipment (See Extract-03 of Table-A showing Details of Property, Plant and Equipment from page 96 of Telstra Annual Report 2016 in Appendix). Management judgement was applied by Telstra in assessing the useful lives of these assets and was based on the anticipated NBNTM network rollout period, Telstra, (2016). The full impact on the useful lives of these assets cannot be assessed fully as of now and will depend on the selection of access technologies by NBN Co. in each of the rollout region and also on the sequence in which this rollout progresses, as per Cichosz, (2014). (See Extract-04 of Table-A Goodwill and other Intangible assets from Page-99 of Telstra’s Annual Report 2016 in Appendix). During the financial year 2016, Telstra has made assessment of its telecommunications network CGU based on the identify indicators of impairment, as has been specified by AASB standard 136. This has been done by using both the external as well as the internal sources of information, asserts Yona, (2011).

Depreciation

Answer – 2 (a) 

Rolling out the services of 4G voice by using the small cells technology was Part of Telstra’s long standing commitment towards expansion of its 4G coverage in the regional Australia. This has made Telstra, the first carrier in Australia which is going to provide 4G voice services to customers using the small cell technology. During this financial year itself, Telstra has identified 50 small cell sites with 4G voice services and have already become operational in rural Australia, Telstra, (2016). A further 10 more such sites are expected to be activated by the end of June. This technology is based on the ongoing investment commitments under the revised NBN DAs which Telstra is making in the rural areas of Australia for its mobile network used by the rural customers, as per Kurth, (2011). 

A small cell is kind of a miniature version of the large size standard base station which are set up by telcos, mostly in highly congested networks found in densely populated urban areas. The purpose of the small cell is also to boost coverage and capacity of the 4G voice calls in rural areas. Being a technical hardware, the small cells are also classified under the Property, Plant and Equipment head in the Annual Report of 2016, Telstra, (2016). Since Telstra’s commitment is Part of its support to the Federal Government’s Mobile Black Spots program, the management is committed to funding up to 250 small cells during its overall expansion program. In this regard, full funding is being provided by Telstra from its internal resources, say Marchildon & McDowall, (2013). 

Deferred Expenditure

A Deferred Expenditure is not only related to the direct incremental costs associated with the establishment of a customer contract, it also relates to the costs incurred for installation and connection fees for providing basic access to existing and new services. It also relates to the deferred costs which are related to the costs incurred on small cell installations under the revised NBN DAs, Telstra, (2016). All such costs, incurred in excess of the future revenues earned, shall be recognised in the subsequent income statement reported in the Annual Report of 2017. The amortised deferred expenditure, which is expected to be realised, shall be recognised in the subsequent operating expenses of 2017, as explained by Cichosz, (2014). 

Answer – 2 (b) 

Telstra’s intangible assets mainly include the following three items –

  1. All IT related development costs of designing, building and testing of new or improvised IT systems.
  2. Research costs which are expensed when incurred.
  3. Capitalised development costs, which include:
  • External direct costs related to materials and services consumed.
  • Payroll and payroll-related costs for employees associated with a project.
  • Borrowing costs which are directly attributed to a qualifying asset. 

All internally generated intangible assets are assessed as having a finite life and hence are amortised over their useful lives on a straight-line basis. Recognition of the development costs are done on the basis of management judgement (Refer to ‘Capitalisation of development costs’), Telstra, (2016). 

Telstra's transfer of assets to NBN Co

Answer – 3 (a) 

Telstra accounts for its acquired joint ventures as well as the associated entities using the equity method. The company recognises the investment under this method at acquisition cost and this is subsequently adjusted by the share of profits or losses received. Such receipts are duly recognised in the relevant income statement of the company under comprehensive income, assert Greuning, Scott & Terblanche, (2011). Telstra entered into venture capital investments in the year 2008, investing mainly in controlled entities and a list of its investments in such controlled entities is detailed in Table –A, Telstra, (2016). 

This table gives details of the company’s material operating controlled entities as at 30 June 2016. This presentation is segregated on the basis of the percentage of earnings before interest, income tax expense, depreciation and amortisation (EBITDA) of each entity and includes the details of Ooyala too, Telstra, (2016). The company’s ownership percentage in Ooyala represents that portion of equity which was held by Telstra in the subsidiary as well as in its immediate parent respectively, according to Mudra, (2014).

The statement confirmed that the fair value of trade and other receivables was equal to the gross contractual amount which the company expected to collect. The goodwill component describes the cost synergies, revenue growth opportunities, workforce talent and the future profitability of the acquired business. No goodwill, recognised at present, is going to be claimed as a deductible expense for income tax purposes. All acquisition costs, incurred during acquisition, have been included under the head ‘other expenses’ in the income statement of the relevant year, assert Keown et al, (2012). 

There are two reasons why companies do this and the first reason is strategic. This happens because the processes have been in-built over the years and hence, it is difficult for managements to avoid or innovate them. The second reason is financial. Companies like Telstra, who are aspiring tech companies are often found to have piled a large amount of excess cash, Telstra, (2016). Hence, acquisitions become an easy way out to invest this excess cash. Moreover, investments made in start-up entities provides Telstra with fresh insight into the emerging industries, as stated by Kurth, (2011). Theoretically, the factor most widely considered by an investing company is to create a hedge against any new, potential competitor. Telstra accounts for the acquisition of its controlled entities by using the Acquisition Method of accounting, Telstra, (2016). This method involves the recognition of the acquiree entities identifiable assets, liabilities and contingent liabilities taken at their fair values as on the acquisition date. Goodwill is recognised as the excess amount over and above the fair value. Telstra deducts the expenses of acquisition as incurred expenses in its income statement, assert Marchildon & McDowall, (2013).

Telstra's roll out of 4G voice services using small cells technology

Current Year Disposals

Telstra’s receipts from sale of businesses including its share in the controlled entities, taken at net of cash disposed, for the current financial year, are $1,340 million. Of this, $1,323 million is from the sale of controlling rights in Autohome Inc. and its controlled entities, on 23 June 2016. (See Extract-06 of Table-B showing Sale of Autohome Group from Page-149 of Telstra’s Annual Report 2016 in Appendix)

Non-controlling Interests

Non-controlling interests, on the date of acquisition, are measured either at their fair value or at non-controlling shareholders’ proportion of the assumed net fair value of the asset. Such transactions are recorded directly under the statement of comprehensive income, as stated by Marchildon & McDowall, (2013).

Contingent Consideration

This is recognised at the fair value of the asset at the time of acquisition, with any changes in the recognised fair value taken in the income statement. In case a business is acquired in stages, Telstra re-measures the previously held equity interest at the acquisition fair value and the resulting gain or loss is shown in the income statement, say Greuning, Scott & Terblanche, (2011). 

Answer – 4 (a) 

Capitalisation of Development Costs

Once the rollout of NBN is completed, Telstra may have to replace all those earnings which will be lost because of this huge outlay. A simple logic is behind this. Whenever a company tries to convert the Development Costs into Capitalisation of Assets, it must suffer the consequences of lost revenues, as per Cichosz, (2014). Development costs should only be capitalised when the project has been, technically and commercially, assessed to be feasible. This in fact depends on the following two factors –

  • Amortisation

The company applies a managed judgement for determining the amortisation period which is based on the expected useful lives of each class of assets. At present, the average amortisation periods of Telstra’s identifiable intangible assets are as shown in Table-D. (See Extract-07 of Table-D showing Amortisation Details from Page-103 of Telstra’s Annual Report 2016 in Appendix)

  • Useful Lives of Intangible Assets

In addition to the above, the company also applies a managed judgement for assessing, on an annual basis, the indefinite useful life assumption which is required to be applied in certain acquired intangible assets. The net calculated effect of such a reassessment of the useful lives, for the financial year 2016, was found to be $67 million as compared to $51 million in 2015, Telstra, (2016). Telstra has already given indications that the rollout of National Broadband Network is bound to cut $2 to $3 billion annually from its earnings. Telstra is sure to remain the biggest telco in Australia, but the management will need to find newer revenue streams or must reduce its debt, once the NBN is active, if it wants to maintain its current A2 credit rating, as stated by Keown et al, (2012). 

Answer – 4 (b)

 The two factors which are going to affect Telstra’s choices, shown above, of its amortisation of software assets are –

  1. Trade and Other Receivables

Once the NBN rollout is completed and it is due by 2020, Telstra may find its earnings margin contracting down to high 30%. Telstra will not be compensated for loss of its earnings by the wholesale business which it is expecting from the rollout, says Mudra, (2014).

  1. Current and Non-current Trade and Other Receivables

Although Telstra will remain the industry leader, it will lose a huge portion of its fixed retail voice and broadband market share. Moreover, its mobile market share is also going to stagnate or may fall due to competitors getting stronger. To permanently fill this earnings gap, Telstra needs to find new revenue streams and to increase its existing streams, Telstra, (2016). Assuming that Telstra has an earnings gap in 2020, it could maintain its credit ratings by either reducing the dividend payments and using the extra cash for cutting its debt or by acquiring extra cash from other sources, such as NBN payments or sale of some of its non-core business, asserts Mudra, (2014).

References 

Baker, H.K. and Riddick, L.A. 2013. International Finance: A Survey. OUP USA, Oxford. 

Cichosz, P. 2014. Data Mining Algorithms: Explained Using R. John Wiley & Sons, West Sussex. 

Greuning, H., Scott, D. and Terblanche, S. 2011. International Financial Reporting Standards: A Practical Guide. World Bank Publications, Washington DC. 

Janousek, V., Moyen, J., Martin, H., Erban, V. and Farrow, C. 2015. Geochemical Modelling of Igneous Processes. Springer, Berlin. 

Keown, A.J., Martin, J.D., Petty, J.W. and Scott, D.F. 2012. Financial Management: Principles and Applications (10th ed). Pearson Education India, New Delhi.

Kurth, S. 2011. Discuss covered interest rate parity (CIRP) with reference to foreign exchange market efficiency. GRIN Verlag, Norderstedt. 

Marchildon, G.P. and McDowall, D. 2013. Canadian Multinationals and International Finance. Routledge, New York. 

Mudra, J. 2014. International Financial Management (12th ed). Cengage Learning, Stamford, CT. 

Telstra Corporation Limited. (AU) Annual Report 2016. Extracted on 1 October 2017 from https://www.telstra.com.au/content/dam/tcom/about-us/investors/pdf-e/FY16-Annual-Report.pdf  

Yona, L. 2011. International Finance for Developing Countries. Author House, Keynes.

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