Telstra Financial Reporting

Telstra Corporation Limited files its financial statements in accordance with the AASB financial guidelines and all other AASB definitive pronouncements. Telstra follows the AASB guidelines, pronouncements, and interpretations in preparing its financial accounts. According to the Conceptual Framework (CF), financial reporting's aim is "to include financial knowledge regarding the reporting agency that is useful to current and future equity, owners, lenders, and other borrowers in making decisions in their capacity as capital providers." The financial reports contain the financial information, and this paper relies extensively on the IFRS Foundation’s Conceptual Framework, the AASB standards, and Telstra’s 2016 annual report.
Telstra’s income statement
Telstra records its revenue “net of sales, trade allowances, discounts, sales incentives, duties, and taxes” (Telstra Annual Report 2016, p.87). Revenue is recognized when it is “probable that the future economic benefits will flow to the company and reliable measurement of the amount is possible.” For instance, for the sale of goods, Telstra recognizes the revenue on delivery of the goods sold, and this prevents a situation where a company records revenue even when the customer fails to take delivery of the goods. In this issue, Telstra complies with the recognition revenue principle, and I believe that it has not overstated its revenues.

A major factor in recognition of its revenues is the revenue arrangements with multiple deliverables. Telstra Annual Report (2016, p. 89) states that “Where two or more revenue-generating activities or deliverables are sold under a single arrangement, each deliverable that is considered to have a value to the customer on a standalone basis is accounted for as a separate unit of accounting.” The allocation is by the standalone selling prices of the two items or an estimate of the selling prices or the fair value of the consideration. According to Aronson (2008, p.24), breaking a deliverable or a contract into separate accounting units and estimation of the prices compromise on reliability since there is nothing that stipulates the actual price. Also, Epstein and Jermakowicz (2008, p.118) states that a company can circumvent the rules on deliverables through issuing separate contracts for each element of a multiple deliverables sale. Therefore, this is one area that Telstra can overstate its revenues.

A highly subjective issue on Telstra’s revenues is the average estimated customer life by which it defers network facilities and installation and connection fees. The company applies managerial judgment, historical information, and customer trends on estimating a customer’s contract life. Since 2015, the average life of Telstra’s network facilities customer is five years

Gupta et al. (2006, p.149) point out that most firms use customer transaction data, but that has a limitation because it does not reveal the underlying motive of the purchase. Also, the life estimates have their basis on micro-models that use data collected at the individual customer level (top-down approach) and ignores the more important foundation of macro-models of demand forecasts (bottom-up). Therefore, Gupta et al. (2006, p.150) argue that the management’s estimate of a life of 5 years does not consider what is on the ground, and this is a contentious issue in Telstra’s recognition of network facility revenues.

Expenses

Telstra, as required by IFRS, uses the matching principle when recognizing its expenses, that is, it matches its expenses with the revenues. A potential problem is the issue of cost allocation of its network facilities where the basis is the average customer life. Gupta et al. (2006, p.150) argue that most companies track costs based on functions rather than customers. Managers might have the intention of reducing costs, and as a result, there is a motive to use a misleading client's life.

Taxes

Telstra had an effective income tax rate of 29.3% in 2015 and 23.5% in 2016. Its income tax expense is the sum of current and deferred income tax expense (Telstra Annual Report 2016, p.92). Deferred income taxes apply to the periods in which the deferred tax assets are realized or when the tax liabilities are settled. The Australian tax rate is 30%, and it differs from the actual tax rate. Telstra (2016, p.92) attributes this difference to four factors: different tax rates in overseas jurisdictions, nontaxable and nondeductible items, amended assessments, and under/over-provision of tax in prior years (Richardson and Lanis 2007, p.690).

The AASB 12 gives guidelines on” recognition of deferred tax liabilities for all the temporary differences”, and Telstra is compliant (Telstra 2016, p.94). Also, Telstra follows the AASB 112 guideline on recognizing deferred tax assets for all deductible temporary differences. On the treatment of unrecognized deferred tax assets, AASB requires an entity to “recognize a previously unrecognized deferred tax asset to the extent that it has become probable that future taxable profit will allow the recovery of deferred tax asset.” Telstra applies management judgment in determining deferred tax assets and in the process, it reviews their carrying amounts to the extent that “it is probable that sufficient taxable profit will be available in the future to utilize this benefit.” Also, if there is a probability that future taxable profit will allow Telstra to benefit, the unrecognized amount could become recognized (Telstra Annual Report 2016, p.94).











The statement of financial position

AASB 116 directs that “An item of property, plant, and equipment that qualifies for recognition as an asset shall be measured at its cost.” Telstra records its PPE at “cost less any accumulated depreciation and impairment, and cost refers to the purchase price plus all costs directly attributable to bringing the asset to the location and condition necessary for its intended use” (Telstra Annual Report 2016, p.97). Telstra depreciates its buildings, communication assets, and leasehold property using the straight line method over their estimated useful lives. AASB 116 allows for the use of a variety of depreciation methods such as the straight line, diminishing balance, and the units of production. Telstra seeks to have a constant change in its depreciation expense over the useful life, and report relatively stable earnings.

Telstra applies managerial judgment in estimating PPE’s useful life. Since the valuation of plant, property, and equipment is dependent upon human judgment, the IFRS invokes for prudence. Prudence refers to “the inclusion of a degree of caution in the exercise of judgments needed in making the necessary estimates under uncertain conditions, such that assets are not overstated” (Martin 2014, p.3). Telstra reviews its PPE for impairment every year, and prudence requires the immediate recording of declines in asset value. However, the company has not indicated whether it revalues its assets and this means that Telstra records increases in values are upon disposal. Telstra has a discontinued operations, and in valuing the other PPE, it factors in the depreciation from these discontinued operations. Not enough details are provided, and in such a case, Telstra is required to exercise caution in these instances.

Inventory

AASB 102 requires that “inventory is measured at the lower of cost and net realizable value, and this is consistent with prudence that provides that assets should not be carried in excess amounts expected to be realized from their sale.” Telstra complies with the AASB and also, uses management’s in determining the NRV by making projections into the future prices as well as the changes in technology. However, the standard requires that NRV estimates be based on the most reliable evidence at the time of estimation and takes into consideration the fluctuation in prices. Therefore, according to the criterion used by Telstra, it seems that the management does not consider price fluctuations.

Accounts receivable

Telstra receivables are in the form of contracted agreements with their customers, and the company requires settlement within 30 days (Telstra Annual Report 2016, p. 104). The company uses an aging schedule to value its trade receivables based on the original date due of the receivables. In estimating the allowance for doubtful debts, Telstra applies management judgment based on historical trends, general economic conditions, credit risk and insolvency risk. The company then uses a statistical approach in segmenting its debt risk and historical impairment rates. For instance, for the year 2016, the closing balance of the allowance for doubtful accounts was -134 million. $46 million was written off for the year 2016, but the company does not record any bad debts in its income statement. Since it is up to the management’s discretion to estimate the allowance, they might understate it to improve its earnings and overvalue the receivables in the statement of financial position (Sherman, Young, & Collingwood 2003).

Leases

When it comes to leases, Telstra does not disclose them in the statement of financial position. It does not explicitly distinguish between finance and an operating lease, that is, its buildings include leasehold improvements but no information on whether it is a capital or operating lease. For the finance leases, it complies with AASB 117 (preceded by AASB 16) which requires that the value is the “lower of the fair value of the asset and the present value of the future minimum lease payments.” For the operating leases, it charges the annual payments to the income statement, for instance, for the year 2016, the rental expense on operating leases was $660 million. By leaving leases off its balance sheet, the company reduces its debt levels, improving its leverage ratio, making it more attractive to investors (Franzen, Cornaggia, & Simin 2009, p.5-6)

However, beginning 2019, Telstra must be prepared for significant changes on recording of its leases after AASB 16 comes into effect. Gibbs et al. (2017, p.4) point out that lessees will have to recognize a right of use asset and a corresponding lease liability for all leases. According to Cornaggia, Franzen, & Simin (2013, p. 350), leasing offered the possibility of off-balance sheet financing for most firms. The proposal to capitalize the capital leases will have the effect of increasing Telstra’s debt levels, contribute to inflationary pressures, and deter expansion in PPE (Wolk,, Dodd, & Rozycki, 2008).

Executive compensation

Telstra’s executive remuneration structure has three elements; fixed remuneration, short-term incentives (STI), and long-term incentives. The fixed remuneration consists of the base salary plus superannuation, and it is primarily based on performance and experience. 75% of the STI is based on financial (EBITDA and total income), customer (net promoter score), and individual performance while the rest 25% is deferred as restricted shares. The LTI seeks to achieve long-term shareholder value creation, and it is in the form of performance rights, with 50% based on relative total shareholder value and the other 50% based on the free cash flow return on investment. Therefore, Telstra’s executive remuneration is linked to both profit and the long-term performance (a minimum of three years) of its shares. A snapshot of the remuneration is available in the appendix section.

The report “EY Pay Perspective 2016 Executive and Board Remuneration Report” by Ernst & Young (2016, 8) points out that remuneration outcomes are increasingly reflecting company performance, both regarding profits and in the stock market, and the link has been strengthening over the past five years. For instance, when it comes to financial performance, Telstra considers earnings which include total income, EBITDA, and net profit, and shareholder value which looks at the share price and the total dividends paid per share (Telstra Annual Report 2016, p.60). For the STI (Telstra Wholesale exempted), the financial outcomes are the EBITDA and free cash-flows.

Lazonick (2014) points out that most companies are engaging in the culture of stock buybacks to extents that shareholders are getting concerned that companies no longer prioritize investing in the future. The drive behind this is the fact that stock-based instruments are a major component of executive remuneration, and by repurchasing shares, stock prices rise. This results in a situation which Lazonick (2014) terms as “from value creation to value extraction.” For instance, during the year 2015, Telstra sent $1.004 billion in cash in a share buyback program, and the interesting thing is that its share price reached $6.14, the highest point since 2012. Therefore, a remuneration policy linked to profits and share prices might drive the culture of organizations to obtain greater profits, for instance, by using a shorter average customer life, Telstra can record earn the network facilities revenue over a longer period.

Prudence in the conceptual framework

Until the year 2010, prudence was part of the IASB’s CF, but it was removed after a revision. However, since the year 2015, the IASB has been proposing to bring prudence back as one aspect of useful financial statements (Cooper, 2015, p.1). A major argument against prudence was the fact that it leads to a bias in the financial reports, and therefore, is in conflict with neutrality (freedom from bias). Hoffman (201, p.8) points out the removal of prudence in the U.S was driven by the fact that people did not like it and it conflicts with neutrality. For instance, it introduces bias in the understatement of assets and the effect is that in later periods, it results in overstatements. The IASB defines prudence as “the inclusion of a degree of caution in the exercise of the judgments needed in making the estimates required under conditions of uncertainty, such that assets and income are not overstated, and liabilities or expenses are not understated.” Investors use financial statements to make decisions, and therefore, any intentional over or under statements by the preparer is likely to result in suboptimal capital allocation decisions.

Fair values, the revenue recognition for construction contracts, and provisions for future costs that might not occur are some accounting items that might be viewed as not prudent. In this case, an honest application of valuation techniques which recognize the effects of uncertainty is a way forward for entities. Also, it means that historical cost for assets and liabilities will be the most appropriate application of prudence.

Arguments for prudence

The public and individual investors believe that companies should exercise some restraint on the over-exuberance by which the management reports the results. Also, there is a need to use caution when making estimates, and therefore, the accounting standards should be supporting this. Martin (2016, p.1) raises the concern over whether a lack of prudence in the 2009 financial crisis resulted in the overestimation and exuberance of unrealized profits and dividends. Therefore, prudence will seek to protect the public’s and investors interests by calling the financial reports prepares to be exercise caution when making estimates.



Argument against prudence

The main argument concerns the issue of neutrality and comparability of the financial statements. By exercising restraint on the profits, prudence simply holds them off for one year, and they are later released in a subsequent year, with exaggeration. Secondly, critics ask the question of; how much of prudence? There seems to be good and bad prudence, and it is not clear how to draw a line between the two. As a result, this poses problems when it comes to comparing financial statements because each company will apply its level of prudence.

In conclusion, the discussion of prudence is necessary IASB develops a proper definition and application guidelines. Standards only provide guidance, and in this case, the management should exercise their judgment in favor of caution and prudence.





















References

Aronson, M., 2008. Revenue Recognition. Available at: http://digitalcommons.bryant.edu/honors_accounting/2/

Cooper, S. (2015). A tale of ‘prudence’. Investor Perspective. [online] IFRS, pp.1-3. Available at: http://www.ifrs.org/-/media/feature/resources-for/.../investor-perspective-jun-2015.pdf [Accessed 21 Aug. 2017].

Cornaggia, K.J., Franzen, L.A. and Simin, T.T., 2013. Bringing leased assets onto the balance sheet. Journal of Corporate Finance, 22, pp.345-360

Epstein, B.J. and Jermakowicz, E.K., 2008. IFRS Policies and Procedures

Ernst and Young (2016). Executive and Board Remuneration Report. EY Pay Perspective 2016. [online] Adelaide: Ernst and Young, pp.1-10. Available at: http://www.ey.com/Publication/vwLUAssets/eys-pay-perspective-2016-executive-and-board-remuneration-report/$FILE/eys-pay-perspective-2016-executive-and-board-remuneration-report%20.pdf [Accessed 21 Aug. 2017].

Franzen, L., Cornaggia, K.R. and Simin, T.T., 2009. Capital structure and the changing role of off-balance-sheet lease financing

Gibbs, M., Pratt, E., Berta, A. and Klunder, D. (2017). AASB 16 Leases A fundamental overhaul of lessee accounting effective 2019. [online] KPMG, pp.1-15. Available at: https://assets.kpmg.com/.../au/pdf/.../aasb-16-fundamental-overhaul-lessee-accounting.pdf [Accessed 21 Aug. 2017].

Gupta, S., Hanssens, D., Hardie, B., Kahn, W., Kumar, V., Lin, N., Ravishanker, N. and Sriram, S., 2006. Modeling customer lifetime value. Journal of service research, 9(2), pp.139-155

Hoffman, C.W., 2016. Revising the Conceptual Framework of the International Standards: IASB Proposals Met with Support and Skepticism. World Journal of Business and Management, 2(1), p.1-20

Lazonick, W. (2014). Profits Without Prosperity. [online] Harvard Business Review. Available at: https://hbr.org/2014/09/profits-without-prosperity [Accessed 21 Aug. 2017].

Martin, R. (2014). Prudence and IFR. The ACCA Global Forum for Corporate Reporting. [online] ACCA, pp.1-10. Available at: http://www.accaglobal.com/content/dam/acca/global/PDF.../tech-tp-prudence.pd [Accessed 21 Aug. 2017].

Richardson, G. and Lanis, R., 2007. Determinants of the variability in corporate effective tax rates and tax reform: Evidence from Australia. Journal of Accounting and Public Policy, 26(6), pp.689-704

Sherman, H.D., Young, S.D. and Collingwood, H., 2003. Profits you can Trust: Spotting & Surviving Accounting Landmines

Telstra Corporation Limited (2016). Telstra Annual Report 2016. Annual Report. pp.1-100.

Wolk, H.I., Dodd, J.L. and Rozycki, J.J., 2008. Accounting theory: conceptual issues in a political and economic environment

















Appendix

Telstra’s Executive Compensation



Telstra’s Top Executive Compensation; Source (Telstra Annual Report 2016, p.55)