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;
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
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The seller's accounting should mirror the buyer's
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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
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The seller's accounting should mirror that of the buyer's
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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.