98/322/EC: Commission Recommendation of 8 April 1998 on interconnection in a liberalised telecommunications market (Part 2 - Accounting separation and cost accounting) (Text with EEA relevance)
Date: 1998-04-08
Institutions: European Commission
Subjects: accounting system, liberalisation of the market, systems interconnection, telecommunications, telephone charges, transmission network

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II

(Acts whose publication is not obligatory)

COMMISSION

COMMISSION RECOMMENDATION

of 8 April 1998

on interconnection in a liberalised telecommunications market

(Part 2 — Accounting separation and cost accounting)

(Text with EEA relevance)

(98/322/EC)

THE COMMISSION OF THE EUROPEAN COMMUNITIES,

Having regard to the Treaty establishing the European
Community,

Having regard to Directive 97/33/EC of the European
Parliament and of the Council of 30 June 1997 on inter-
connection in telecommunications with regard to en-
suring universal service and interoperability through the
application of the principles of open network provision
(ONP) (1), and in particular Article 7(5) thereof,

Whereas Directive 97/33/EC gives national regulatory
authorities for telecommunications (NRAs) an important
role in securing adequate interconnection of networks, in
accordance with Community law,
taking into account
recommendations laid down by the Commission so as to
facilitate the development of a genuine European home
market; whereas, in particular, Article 7(5) of Directive
97/33/EC requires the Commission to draw up recom-
mendations on cost accounting systems and accounting
separation;

Whereas Article 7(2) of Directive 97/33/EC requires that
certain organisations notified by their NRA as having
significant market power (hereinafter referred to as ‘noti-
fied operators’) should follow the principles of
trans-
parency and cost orientation for interconnection charges;

Whereas Article 8(2) of Directive 97/33/EC requires noti-
fied operators to keep separate accounts for, on the one

their

activities

hand,
related to interconnection —
covering both interconnection services provided internally
and interconnection services provided to others — and,
on the other hand, other activities, so as to identify all
elements of cost and revenue, with the basis of their
calculation and the detailed attribution methods used,
related to their interconnection activity,
including an
itemised breakdown of fixed asset and structural costs;

the Commission in its

Whereas
recommendation
98/195/EC of 8 January 1998 (2) on interconnection in a
liberalised telecommunications market (Part 1 — Inter-
connection pricing) considers that the most appropriate
approach to interconnection pricing is one based on
forward-looking long-run average incremental costs, since
this is the most compatible with a competitive market;
whereas this approach does not preclude the use of justi-
fied ‘mark-ups’ as a means of recovering such forward-
looking joint and common costs of an efficient operator
as would arise under competitive conditions;

incremental

long-run average

Whereas an approach to interconnection pricing based on
costs
forward-looking
entails an accounting system based on current costs rather
than historic costs; whereas the Commission has recom-
mended Member States (in the recommendation of 8
January 1998) to set deadlines for the implementation by
their notified operators of new accounting systems based
on activity based costing; whereas although the bottom-up

(1) OJ L 199, 26. 7. 1997, p. 32.

(2) OJ L 73, 12. 3. 1998, p. 42.

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economic/engineering models
are becoming highly
sophisticated, they are as yet imperfect, and thus recon-
ciliation of top-down and bottom-up approaches is ad-
vised for the foreseeable future;

whereas, in particular, transparency is required in respect
of cost-accounting of operators providing both fixed
networks and mobile telecommunication networks;

Whereas Article 7(5) of Directive 97/33/EC requires
NRAs to ensure that a description of the cost-accounting
system, showing the main categories under which costs
are grouped and the rules used for the allocation of costs
to interconnection, is made available on request to in-
terested parties; whereas allocation methods need to be
displayed at a level of detail that makes clear the relation-
ship between costs and charges of networks components
and services (that is to say, usage factors); whereas the
basis on which unattributable costs have been allocated
between different accounts also needs to be provided;
whereas compliance with the cost accounting system has
to be verified by the national regulatory authority or some
other competent body, independent of the telecommun-
ications organisation and approved by the NRA; whereas
a financial statement concerning compliance has to be
published annually;

Whereas Articles 12(1) and 13(1) of Directive 95/62/EC of
the European Parliament and of
the Council of 13
December 1995 on the application of open network
provision (ONP) to voice telephony (1) requires tariffs for
use of the fixed public telephone network and the voice
telephony service to follow the basic principles of cost
orientation and transparency, including the implementa-
tion by notified operators of a suitable cost accounting
system for this purpose; whereas contributions by inter-
connected-parties to ‘access deficit’ type schemes are only
permissible when tariff constraints are imposed by NRAs
on the grounds of affordability and accessibility of tele-
phone service in accordance with Article 12(2) of Dir-
ective 95/62/EC; whereas the Commission, in its com-
munication of 27 November 1996 on assessment criteria
for national schemes for the costing and financing of
universal service in telecommunications and guidelines
for the Member States on operation of such schemes (2),
believes that such schemes should disappear by 1 January
2000;

services (5)

telecommunications

Whereas Article 2 of Commission Directive 95/51/EC of
18 October 1995 amending Directive 90/388/EEC with
regard to the abolition of the restrictions on the use of
cable television networks for the provision of already
liberalised
requires
Member States to ensure accounting transparency and to
prevent discriminatory behaviour where an operator
having an exclusive right to provide public telecommun-
ications network infrastructure also provides cable TV
network infrastructure, and in particular to ensure the
separation of financial accounts as concerns the provision
of each network and its activity as provider of telecom-
munication services; whereas under Article 8(1) of Dir-
ective 97/33/EC notified operators which have special or
exclusive rights for the provision of services in other
sectors (cable or satellite TV broadcasting) are required to
keep separate accounts of telecommunication activities
and the others, to the extent that would be required if the
telecommunications activities in question were carried out
by legally independent companies or to have structural
separation of
telecommunication activities and other
activities.

public

providing

Whereas Article 8(3) of Directive 97/33/EC requires
organisations
telecommunications
networks and/or publicly available telecommunication
services to supply financial
information to their NRA
promptly on request and to the level of detail required;
whereas NRAs may publish such information as would
contribute to an open and competitive market, while
taking account of considerations of commercial confiden-
tiality;

Whereas the application of the principles of this recom-
the
mendation is without prejudice to the duty of
Member States and of undertakings to comply fully with
the Community competition rules, taking account of the
specific positions set out in the communication from the
Commission on the application of the competition rules
to access agreements in the telecommunications sector (6);

Whereas Commission Directive 90/388/EEC of 28 June
1990 on competition in the markets for telecommunica-
tions services (3), as amended by Directive 96/2/EC (4),
requires Member States to ensure effective competition
between operators competing in the relevant markets;

Whereas the advisory committee set up by Article 9(1) of
Council Directive 90/387/EEC (7) (‘the ONP Committee’)
has given broad support to the principles contained in
this recommendation, and the Commission has taken
utmost account of the views expressed,

(1) OJ L 321, 30. 12. 1995, p. 6.
(2) COM(96) 608.
(3) OJ L 192, 24. 7. 1990, p. 10.
(4) OJ L 20, 26. 1. 1996, p. 59.

(5) OJ L 256, 26. 10. 1995, p. 49.
(6) OJ C 76, 11. 3. 1997, p. 9.
(7) OJ L 192, 24. 7. 1990, p. 1.

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MAKES THE FOLLOWING RECOMMENDATION:

1. This recommendation concerns the implementation
of accounting separation and cost accounting systems
by operators designated by their NRA as having
significant market power (hereinafter referred as ‘noti-
in accordance with Article 8(2) of
fied operators’)
Directive 97/33/EC for implementation of intercon-
nection obligations, with particular regard to the prin-
ciples of transparency and cost orientation.

Further disaggregated accounts within these broad
business lines may be considered appropriate by
NRAs, regard being had to transparency and compet-
itive requirements demanded by national or Com-
munity law (such as mobile, cable TV or international
activities).

3. It is recommended that the allocation of costs, capital
employed and revenue be done in accordance with
the principle of cost causation (such as activity-based
costing (ABC)).

The purpose of accounting separation is to provide an
analysis of information derived from the accounting
records to reflect as closely as possible the per-
formance of parts of
they had
operated as separate businesses.

the business as if

The costing system of the notified operators need to
be sufficiently detailed to permit — as far as possible
— the allocation of costs to unbundled network
components, in particular to determine the cost of
unbundled interconnection services.

2. It

is recommended that NRAs require from their
notified operators the disaggregation of their oper-
ating costs, capital employed and revenues, into at
least the following broad business lines:

A well defined cost-allocation system will enable at
least 90 % of the costs to be allocated on the basis of
direct or indirect cost-causation (2).

Core network (switched infrastructure)

The core network covers the provision of intercon-
nection services, transit services and carrier’s carrier
services.

Local access network (local loop infrastructure)

The local access network covers the provision of
connections to the telephony network (1).

Retail

The retail business covers the activities mainly related
fixed telephony
to the commercial provision of
services and leased lines
to end users. Separate
accounts may be prepared for each activity within
retail that is subject to regulation (such as leased lines
or telephony).

Other activities

‘Other activities’ covers other activities provided by
the notified operator which may include unregulated
activities as well as other type of regulated activities.
Accounts for regulated and unregulated activities need
to be kept separate.

Section 1 of the Annex defines the scope of each
business. Transfer charges between businesses are
identified in Section 2.

(1) This will include those components of the network which are
not traffic sensitive and are dedicated to a particular customer
including, for example, the local loops and the line cards and
ports located at concentrators and/or exchanges.

It is recommended that unattributable costs (the cost
which can only be attributed on an arbitrary basis) be
clearly identified in a specific account and be the
subject of a specific treatment by the NRA (that is,
they should be distributed according to the rules
determined by each Member State,
in accordance
with the Community’s competition rules and in
compliance with the principles of transparency and
proportionality).

It is recommended that the NRA undertakes a public
consultation with market players on the adoption of
sound allocation methods and on the specific treat-
ment to be given to unattributable costs.

Section 3 of the Annex outlines the recommended
principles for allocating costs, capital employed and
revenues when preparing separate accounts.

Section 4 of the Annex provides guidance on the
application of those principles to the calculation of
operating costs,
including depreciation; Section 5
does the same for the cost of capital and capital
employed, and Section 6 on revenues.

4. In the recommendation of 8 January 1998, NRAs
were recommended to set deadlines for their notified
operators’
implementation of new cost accounting
systems based on current costs.

(2) Directly attributable costs are those costs that can be directly
and unambiguously related to a product or service. Indirectly
attributable costs are those costs that can be apportioned to
products or services on a measured non-arbitrary basis based
on the relationship of the costs with directly attributable costs
(i.e. using usage factors for each consuming shared resources).

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7. It

is

relevant
recommended that NRAs make
accounting information from notified operators av-
ailable on request to interested parties at a sufficient
level of detail to ensure that there has been no undue
services
discrimination between the provision of
internally and those provided externally, and to
enable the average costs of unbundled interconnec-
tion services to be identified.

respect,

the publication by the notified
In this
operator of
statements
sufficiently detailed cost
showing the average cost of network components will
increase transparency and raise confidence on the
part of competitors, that there are no anti-competitive
cross-subsidies. This is considered to be particularly
important
for cross-border interconnection services
and international activities.

to finance universal

In addition,
for those Member States that operate
service obligations
schemes
and/or access deficit contributions, it is also recom-
mended that NRAs make available sufficient ac-
counting information from notified operators
to
there is no discrimination between
ensure that
charges levied on other operators and those levied
(implicitly) internally.

8. These accounting guidelines are concerned with regu-
latory reporting and they are not intended as a re-
placement for any statutory financial reporting that
may be required in the Member State.

9. This

recommendation will be reviewed by the

Commission by 31 July 1999 at the latest.

10. This recommendation is addressed to the Member

States.

Done at Brussels, 8 April 1998.

For the Commission

Martin BANGEMANN

Member of the Commission

It is recommended that the methodology and criteria
for the evaluation of network assets at current value is
fixed by the NRA after a public consultation with
market players.

Evaluation of network assets at forward-looking or
current value of an efficient operator, that is, at the
value that would prevail if the market were vigorously
competitive,
is a key element of the ‘current cost
(CCA) methodology. This requires that
accounting’
the depreciation charges included in the operating
costs be calculated on the basis of current valuations
of equivalent assets, and consequently the reporting
on the capital employed also needs to be on a current
cost basis.

The Appendix of the Annex provides guidance on
modern asset valuation and current cost adjustment
methodologies.

5. With regard to the derivation of

interconnection
pricing, NRAs may require efficiency factors to be
applied in recognition of the fact that the use of CCA
values for the network may not fully reflect the costs
of an efficient operator (1). To this end the ‘best prac-
tice interconnection charges’ as provided in the
recommendation of 8 January 1998 constitute a
suitable point of reference.

6. It is recommended that operators required to report
accounting separation provide a profit and loss state-
ment and balance sheet for each of the separate busi-
nesses. Transfer charges or purchases between busi-
nesses need to be clearly identified.

The recommended content and formats of the finan-
cial regulatory reports to be provided by the notifed
operators are indicated in Section 7 of the Annex.

For consistency, it is recommended that the financial
reports of
these separate regulatory accounts be
consolidated into a profit and loss statement and a
balance sheet for the company as a whole. A recon-
ciliation of the separate regulatory accounts to the
statutory accounts of the operator is also suggested.

(1) Some of the assets may be in excess of requirements or net-
work architecture may be sub-optimal. Implementation of a
bottom-up economic/engineering model will help provide in-
formation about these inefficiencies.

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ANNEX

GUIDELINES ON IMPLEMENTING ACCOUNTING SEPARATION

1. Accounting separation

1.1. Local access network

Local access network provides connections to the core networks. The accounts for the local access network
business will include the costs and capital employed associated with providing and maintaining these
connections.

For accounting separation, the local access network business will include all the customer-dedicated com-
ponents of the network including, for example, the line cards and ports located at concentrators and/or
exchanges. The core network business will include all other network components.

Customer line rental will be a service provided by the retail business. The revenue from line rental provided
to end users will therefore be recorded against retail. However, line rental revenue from unbundled local
loops where these are made available to other market players will need to be assigned to local access network
business.

Thus, the cost of providing customer lines will initially be recorded against the local access network business
and there will need to be a transfer of costs to retail in order to match revenues with their associated costs.
The costs transferred to retail should be net of any possible local access revenue such as line rental revenue
from other market players or access deficit contributions (see Section 2.2).

1.2. Core network

The core network business provides a range of wholesale interconnection services internally and externally in
order to allow the customer of one operaor to communicate with customers of the same or another operator,
or to access services provided by another operator. These services include the switching and conveyance of
calls. In addition, the core network business may provide other services to operators, such as engineering
services related to the development and maintenance of private networks and to the development of com-
petition (e.g. number portability and carrier selection).

The accounts for the core network business will include the costs, revenues and capital employed associated
with the provision of these services. The revenues of the core network business will derive principally from
the sale of interconnection services to the retail business and to other operators.

If national regulation permits wholesale provision of transmission circuits, the associated revenues should be
booked to the core network business.

1.3. Retail

The retail business includes all those activities involving the selling of telephony services to end-users, in-
cluding line rental, leased lines, calls, payphones and the provision of directory information.

The accounts for the retail business will include the costs, revenues and capital employed associated with the
provision of these services to end users. The costs allocated to retail will include transfer charges related to
the use of network resources or services provided by local access network and the core network businesses,
and the marketing and billing costs associated with the provision of end user services.

NRAs will need to consider the extent to which the retail accounts should be further disaggregated to distin-
guish between the costs and revenues of individual services taking into account the transparency require-
ments of national and Community law. Separate accounts should be prepared for each activity within retail
that is subject to regulation. It would not, however, be appropriate to require separate accounts to be prepared
for activities that are not subject to regulatory control (1).

(1) In principle, the extent to which separate accounts are prepared for individual retail activities may be expected to

diminish over time as the provision of services becomes more competitive.

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1.4. Other activities

Incumbent operators typically provide a wide range of other services including the rental, repair and main-
tenance of customer equipment. In addition, they may have interests in non-telecommunications activities
(e.g. TV broadcasting). For the purposes of accounting separation, the costs, revenues and capital employed
associated with these activities will be separately identified.

NRAs may consider that individual accounts should be prepared for some of these additional activities. This
may be especially relevant for those incumbent operators that do not operate their mobile activities as sep-
arate businesses. It will be up to individual NRAs to specify the extent to which separate accounts for these
activities will be prepared taking into account the transparency requirements of national and Community
law.

2. Transfer charges

This section of the guidelines sets out the principles to be applied by operators in order to take account of
the costs of products or services that are used internally.

A system of transfer charges should apply to services and products provided from one business (for example,
local access network, core network and retail) to another.

There should be a clear rationale for the transfer charges used and each charge should be supportable.
Charges should be non-discriminatory and, as discussed in Section 7, there should be transparency of transfer
charges in the separate accounts.

2.1. Measuring internal usage

The transfer charges for internal usage should be determined as the product of usage and unit charges. The
charge for internal usage should be equivalent to the charge that would be levied if the product or service
were sold externally rather than internally.

For accounting separation purposes, it should be assumed that an operator’s retail business pays the same
interconnection charge for the same service.

2.2. Access deficit contributions and universal service contributions

The Interconnection Directive requires charges for interconnection to be separated from charges related to
universal service, including any charges imposed as a result of operators being prevented by NRAs from
rebalancing tariffs (i.e. access deficit contributions or ADCs). The Commission has indicated that tariff re-
balancing should be completed by 1 January 2000 except in those Member States which have been granted
an additional implementation period in accordance with the Full Competition Directive (1).

In those Member States that operate access deficit schemes, ADCs should be assigned to the local access
network business. ADCs would be recovered from other operators and from the retail business. There should
be no discrimination between ADCs charged to retail and ADCs charged to other operators.

In those Member States that operate schemes to finance universal service obligations, any contributions —
both by other operators and internally — should be separately identified in the accounts. As with ADCs,
there should be no discrimination between universal service contributions charged to other operators and
contributions charged internally.

3. Principles of cost allocation

This section sets out the principles that should be followed in order to allocate costs, capital employed and
revenues for the purposes of preparing separate accounts. The application of these principles to operating
costs, capital employed and revenues is considered in more detail in Sections 4, 5 and 6 respectively.

(1) Source: Communication from the Commission on assessment criteria for national schemes for the costing of universal
service in telecommunications and guidelines for the Member States on operation of such schemes, COM(96) 608 final,
Brussels, 11 November 1996.

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These principles may also be relevant to the determination of interconnection charges for unbundled inter-
connection services, for which purposes the costing systems of operators will need to be sufficiently detailed
to permit — as far as possible — the allocation of costs to unbundled network components. There are,
however, a number of additional factors — such as the relevance of costs — that may need to be taken into
account when determining charges for specific interconnection services (1). These issues are outside the scope
of these guidelines.

3.1. Principles

Accounting separation should be based on the principle of causation: that is, costs (2) and revenues should be
allocated to those services or products that cause those costs or revenues to arise. This requires the imple-
mentation of appropriate and detailed cost allocation methodologies. In practice, this requires that operators:

— review each item of cost, capital employed and revenue,

— establish the driver that caused each item to arise, and

— use the driver to allocate each item to individual businesses.

All allocations may be subject to review by NRAs.

Each item of cost and revenue must be allocated to the products and services provided by operators. In the
case of revenue, it is anticipated that most, if not all, revenues can be allocated directly to those products or
services to which they are related. This is not the case for costs, however, because a relatively high proportion
of the costs of operators is shared between different products and services.

3.2. The methodology for the cost allocation process

Figure 1 illustrates a typical cost allocation process. It should be noted that actual allocation processes may
vary depending on the entity’s organisational structure and the way(s) in which financial/operating data are
captured, and will be considerably more complex and involved than Figure 1 implies. It is important to note,
however, that the ultimate aim of allocating costs is the same.

The process starts from information and data captured by the general ledger or other costing or financial
systems operated by the company. The costing information held by these systems may be divided between
operating costs, capital costs and accounting entries such as depreciation.

Costs may be attributed either directly to services or to cost pools called network components, related func-
tions or other functions. These are defined as follows:

Services

These are the costs that can be directly identified with particular service. For these purposes, the term
‘service’ refers both to end-user services (e.g. the provision of payphones) and intermediate services (e.g.
network services).

Network components

This pool contains the costs relating to the various components of transmission, switching and other network
plant and systems. The costs will be in respect of network components that cannot be attributed directly to a
particular service as they are utilised in the provision of a number of services.

Related functions

This pool contains the costs of functions necessary for the provision of services to the customer such as
billing, maintenance, and customer services.

Other functions

This pool contains the costs of functions that are not related to the provision of particular services but are an
important part of the operations of the company. Examples of such costs include planning, personnel and
general finance.

(1) The nature of which may be expected to change over time in response to changing market requirements.
(2) Including operating and capital costs.

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As noted, there are a series of steps which allocate cost pools in a tiered approach to eventually allocate costs
to services. These step allocations are performed using appropriate drivers. Each step is summarised below:

Step 1

The allocation of other functions across related functions, network elements and services.

Step 2

The allocation of the related function costs to services and the network elements.

Step 3

The allocation of network components to services.

Step 4

The grouping of services into businesses (as defined for the purposes of accounting separation).

Each of the allocation steps illustrated above could involve a number of detailed sub-steps, particularly if the
initial capture of cost information is at an aggregated level. Where it is possible to perform an allocation via a
number of direct or indirect attributions this is preferable to allocation through a single arbitrary step.

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Figure 1

A typical cost allocation process

Operating 
costs

Capital
costs

Accounting
entries

e.g. depreciation

DATA
CAPTURE

ALLOCATION

Services

Network
components

Related 
functions

Other 
functions

STEP 1

ALLOCATION OF COSTS 
OF OTHER FUNCTIONS

Services

Network
components

Related 
functions

STEP 2

ALLOCATION OF COSTS
OF RELATED FUNCTIONS

Services

Network
components

STEP 3

ALLOCATION OF COSTS
OF NETWORK COMPONENTS

Services

STEP 4

ALLOCATION OF COSTS
OF SERVICES

Businesses

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It is anticipated that telecommunications operators will need to use sampling techniques and periodic
activity reviews in order to allocate costs (including capital costs) to the services that they provide and,
subsequently to the businesses defined for the purposes of accounting separation. For example, periodic
analysis of the tasks undertaken by staff in customer call centres may be used to determine the amount of
time spent by those staff on different tasks. This information may then be used to allocate — either directly
or indirectly — the costs associated with the staff to the services provided by the operator.

4. Operating costs

This section of the guidelines considers the application of the principles described in Section 3 to the oper-
ating costs, including depreciation, of operators.

Application to operating costs

The cost allocation process outlined in the previous section relates, in principle, to both operating and
capital costs. Table 4.1 below provides a summary of possible allocation and attribution methods for oper-
ating costs under the following headings:

— depreciation,

— provision, installation and maintenance costs,

— network planning and development costs,

— network management costs,

— marketing and sales costs,

— billing and collection costs,

— operator services costs,

— directory services costs,

— payments to other operators, and

— support costs.

These headings are purely illustrative and are not intended to reflect the way in which operators are expected
to record costs. They are intended to provide high-level guidance only. Individual operators will need to
develop cost allocation procedures specific to the way in which they currently capture and record costs, and
to refine these over time, as appropriate.

The final column of Table 4.1 provides an indication of the principal businesses to which it might be
expected that the majority of the operating costs in question would be allocated.

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L 141/18

‹

EN

‹

Official Journal of the European Communities

13. 5. 98

5. The cost of capital and capital employed

Article 7(2) of the Interconnection Directive requires that charges for interconnection be cost-oriented, in-
cluding a reasonable return on investment. The determinants of the level of this return are:

— the cost of capital, and

— a capital value.

The calculation and setting of a cost of capital for the purpose of setting interconnection charges is outside
the scope of these guidelines. However, there must be consistency between the measure of capital employed
on which the cost of capital is based and the measure of capital employed reported in the separate accounts
required by the Interconnection Directive.

This will enable comparison of the actual percentage returns earned by operators from their regulated
activities such as interconnection with the cost of capital allowed by NRAs when reviewing charges for these
activities. The need for consistency, and the implications of this for the allocation of items of capital
employed, are the focus of this section.

5.1. Cost of capital

The cost of capital of operators should reflect the opportunity cost of funds invested in network components
and other related assets. It conventionally reflects the following:

— the (weighted) average cost of debt for the different forms of debt held by each operator,

— the cost of equity as measured by the returns that shareholders require in order to invest in the network

given the associated risks, and

— the values of debt and equity.

This information can then be used to determine the weighted average cost of capital (WACC) using the
following formula:

WACC = re

. E/(D+E) + rd . D/(D+E)

where re is the cost of equity, rd is the cost of debt, E is the total value of equity and D is the total value of
interest-bearing debt.

The calculation of the WACC for an individual operator in total would be relatively straightforward —
notwithstanding that there is scope for discussion about the precise derivation and value of inputs into the
WACC formulae. However, NRAs may need to consider whether application of the global cost of capital
represented by the WACC is appropriate for the regulated activities of operators. If so, the WACC in total
could be used for the purpose of determining interconnection charges.

Otherwise, NRAs may take into account that different risks premiums normally apply to different activities,
which could be reflected in different costs of equity ‘re’ (1), even if the financial structure is the same. If so,
there could be a different WACC for each business line or disaggregated activity such as mobile, cable TV or
international services.

5.2. The WACC and capital value

The WACC must be applied to a capital value for network components and other related assets in order to
determine the return that needs to be recovered through interconnection charges. While it may be easy to
identify the values of debt and equity for an operator as a whole, it is not easy to do so for each of its con-
stituent activities. This is because decisions about debt finance are largely corporate decisions determined by

(1) Financial economics, and actual investor behaviour, teach that the cost of equity ‘re’ is equal to the cost of risk-free debt
plus a risk premium depending on the underlying activity and on the financial market used. Activities with higher com-
petition usually carry higher risk. The cost of debt ‘rd’ also varies between activities between companies, but — for a given
financial market — not as much as the cost of equity ‘re’. As for the capital structure (E and D), it should also reflect the
balance sheet of each main activity. Where there is only one main balance sheet for several activities, it is acceptable to
assume the same capital structure for these activities. In this context, the cost of debt ‘rd’ can normally be assumed the
same for all activities, unless they have markedly different balance sheets.

13. 5. 98

‹

EN

‹

Official Journal of the European Communities

L 141/19

a number of factors, such as historical borrowing facilities and tax planning considerations. Hence, the debt
position of the corporation may not relate specifically to the funding requirements of individual activities.
An alternative approach to determining the capital value for regulated activities (such as interconnection) is
therefore required.

One approach is provided by the following balance sheet identity:

Shareholders’ funds (i.e. equity) + debt = net assets excluding debt (1).

It follows that the capital values of regulated activities can be determined by apportioning net assets or
capital employed. This apportionment should be carried out on a causal basis and under current valuation
methodologies.

5.3. Capital employed

Table 5.1 provides a summary of possible allocation methods for different items of capital employed,
together with an indication of the principal businesses to which it might be expected that the majority of
each item would be allocated. The application of these and, as appropriate, other methods will determine the
capital values of different regulated activities, including interconnection.

The table is not intended to be an exhaustive list of items that might be classified as capital employed nor of
the methods for allocating them to different activities.

(1) That is, fixed assets + current assets – creditors (excluding debt) provisions.

L 141/20

‹

EN

‹

Official Journal of the European Communities

13. 5. 98

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EN

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Official Journal of the European Communities

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13. 5. 98

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L 141/23

For price-setting purposes, NRAs and operators will be concerned with average capital employed during any
period rather than with capital employed at a single point in time such as the financial year end. This is
because a ‘snap-shot’ at any point in time may not be representative of the average level of capital employed
by operators. Specifically, working capital balances at a single point in time may not be representative of
average working capital requirements over an extended period. The separate accounts of operators should
therefore show average capital employed, rather than year-end balances (see Section 7).

5.4. The need for consistency in the treatment of working capital

Table 5.1 proposes one approach to the treatment of working capital in the calculation of capital employed.
There are, however, other approaches which may be equally valid. In practice, there are two principles that
ought to be applied when considering the treatment of individual items of working capital for the purposes
of separate accounting (1). They are as follows:

— there should be consistency between the treatment of assets and their associated costs and revenues, and

— inclusion or exclusion of individual items ought, in principle, to have a corresponding impact on the
WACC. These two effects (i.e. the decision to include or exclude items and the corresponding adjustment
to the WACC) offset each other in terms of their overall effect on the absolute return required by
operators.

6. Revenue

Section 3 set out some principles for the allocation and attribution of costs and revenues to the products and
services offered by operators. In this section the application of these principles to revenue is considered.

6.1. Revenue from core telephony activities

It is expected that revenues from the provision of core telephony products and services can be directly
allocated to the products and services to which they relate based on accounting records and billing system
information. In those cases where direct allocation based on accounting records or billing system data is not
possible, revenues should be attributed on the basis of causation.

The allocation of revenues from core telephony services between local access network, core network and
retail for a fixed telephone network is summarised below (2).

Connection charges

Charges for establishing new connections to the fixed telephone network (other than for establishing a point
of interconnect — see interconnection charges below) should be assigned to retail.

Customer line rental charges

Line rental charges should be assigned to retail.

Revenues from leased lines

Revenue from leased lines should be allocated to retail.

Revenues from line rental

to other operators

Where provided to other market players, revenue from line rental of unbundled local loops should be
assigned to local access network.

Access deficit contributions

In those Member States that operate access deficit schemes, access deficit contibutions should be allocated to
local access network.

(1) The Arthur Andersen report on accounting separation in the context of ONP provides further guidance on the applica-
tion of these principles to the treatment of fixed asset investments, short-term investments, long-term provisions, and lia-
bilities for taxation and dividends. These are potentially contentious areas which must be seen in the context of sound ac-
counting practices within each Member State and, therefore, they are outside the scope of these guidelines.

(2) The same principles can be applied by analogy to other networks.

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Universal service contributions

In those Member States that operate schemes to finance universal service obligations, contributions from
other operators should be allocated to retail. In addition, there should be an explanatory note to the accounts
demonstrating that there is no discrimination between the contributions charged to other operators and
those charged (implicitly) internally.

Interconnection charges

Interconnection charges, including the one-off costs of establishing a point of interconnect and volume-
related charges, should be allocated to core network.

Call charges

Revenue from call charges should be allocated to the appropriate service within the retail business.

Equipment rentals and sales

Revenue from the rental and sale of equipment such as telephones and facsimile machines should be
allocated to the appropriate services within ‘other activities’.

Revenue from advertising in directories

Revenue received from advertising in directories should be allocated to a directory services account in ‘other
activities’.

Engineering services/consultancy

Revenue from engineering services/consultancy other than for interconnection should be allocated to ‘other
activities’.

6.2. Other revenue

Operators may also generate income from non-telephony services. In accordance with the principle of causa-
tion these should be allocated to the activities to which they relate.

One example would be revenue from sub-letting parts of properties used by the core telephony businesses,
the revenue from which could be treated in a number of ways. Options include:

— treating the revenue as revenues for the business sub-letting the accommodation, and

— recording the revenue under ‘other activities’.

No one approach is necessarily better than the others that may be available. However, it is important that the
revenues from non-core activities and the costs associated with them are treated consistently. Failure to do so
would lead to the profits of one business being understated and the profits of another overstated.

Income from fixed asset investments

Income from fixed asset investments should be allocated in the same way as the investments to which they
relate. Given the approach adopted in Section 5 to the allocation of pure financial investments and invest-
ments in unrelated activities the income from these investments would be allocated to ‘other activities’.
Income from fixed asset investments should only be allocated to local access network, core network or retail
if the related investments are allocated in this way.

Income from short-term investments

The same principles apply to income received from short-term investments. The income should be allocated
to the business to which the associated investment is allocated.

7. Reporting requirements

This section of the guidelines sets out the information that operators should prepare for the purposes of
accounting separation and consider the extent to which it should be published.

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7.1. Suggested accounts

Separate accounts for the local access network, core network and retail activities of operators should be
prepared with information relating to ‘Other activities’ summarised in a single set of accounts (1).

The following information should be prepared for each set of accounts:

— a profit and loss statement, and

— balance sheet information in a form that is consistent with the measure of capital employed used for

price-setting purposes.

Operator’s retail activities include both regulated and unregulated activities. Separate accounts for each regu-
lated activity should be prepared. NRAs will need to determine the retail activities for which separate
accounts should be prepared taking into account the transparency requirements of national and Community
law.

It would not be appropriate to require operators to reveal detailed financial information about their unregu-
lated activities that they would not otherwise be required to reveal for statutory reporting purposes. Such
information may be regarded as commercially confidential. Information relating to such activities should
instead be shown in total and reported as ‘retail — other activities’.

7.2. Content of reports

A suggested profit and loss account and balance sheet for core network for the purposes of accounting
separation are shown in Figure 7.1 at the end of this section. Suggested formats for local access network,
retail and other activities are shown in Figures 7.2, 7.3 and 7.4 respectively.

All accounts should make explicit any transfer charges to or from other businesses. For example, charges
paid by the operator’s own retail activity for interconnection services should be clearly shown as a cost in the
retail accounts and as a revenue item in the core network accounts.

The accounts should also make explicit any differences between the costs allocated to different activities by
the operator and the costs that the NRA allowed for the purpose of determining charges. This will provide
transparency about the extent of costs excluded by the NRA for charging purposes and about the reasons for
their exclusion.

7.3. Basis of the preparation

Separate accounts should be prepared on a current cost basis. The Appendix provides guidance on the ap-
plication of current cost accounting concepts.

7.4. Audit requirements

As set out in Article 8 of the Interconnection Directive, the separate accounts prepared by operators must be
subject to independent audit in accordance with the relevant rules of national legislation.

7.5. Other information

The following information should also be prepared as part of accounting separation:

— a statement of accounting policies used in the preparation of the accounts,

— a reconciliation of the separate accounts to the statutory accounts of the operator,

(1) If, as discussed in Section 1, NRAs require that separate sets of accounts should be prepared for certain ‘other activities’,
reports should also be prepared for these. This would reduce the scope of activities included in the ‘other activities’ ac-
counts.

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13. 5. 98

— a matrix summarising the total transfer charges between different accounts. This matrix will make
explicit the total charges from, for example, core network to retail and will be an input into the
reconciliation of the separate accounts to the statutory accounts,

— a statement describing the basis on which unattributable costs have been allocated between different

accounts (1),

— information about the cost allocation methodologies employed in order to prepare separate accounts.
This should be at a level of detail that makes clear the relationship between costs and interconnection
charges,

— a statement showing the average cost of network components, and

— in those Member States that operate schemes to finance universal service obligations, an explanatory note
demonstrating that there is no discrimination between charges level on other operators and those levied
(implicitly) internally.

The format in which the above information should be presented is for operators to determine in consultation
with their NRA.

The Interconnection Directive also requires that operators provide interconnection to other operators under
the same terms and conditions as they provide for their own services (i.e. internally) or those of their sub-
sidiaries or partners. For these purposes, operators will need to provide information to their NRA demonstra-
ting that there has been no undue discrimination between the provision of services internally and those
provided externally. It is for each NRA to consider how this information should be provided and the process
by which such information will be validated.

7.6. Publication of information

Publication of information required in the Interconnection Directive serves a number of purposes including
the following:

— makes transparent the relationship between interconnection charges and costs,

— provides transparency about the interconnection charges paid by the operator’s own Retail activities and
assurance that there was no undue discrimination between internal and external provision of intercon-
nection services, and

— helps to establish confidence in the interconnection regime.

NRAs should encourage publication of as much of the above information as possible.

Information that is proven to be commercially confidential should not be published.

There will inevitably be changes in the cost allocation methods used by operators, particularly for those
operators that have not historically been required to prepare separate accounts. Accordingly, NRAs should
consider the extent to which the above information is published in the first year after adoption of the Inter-
connection Directive. The cost allocation methodologies employed by operators should be published im-
mediately.

(1) Best practice is to allocate unattributable costs in the ex post financial reports in the same way as they were allocated for

the purposes of price setting.

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Figure 7.1.

Suggested reporting formats for the core network business

(a) Profit and loss

Turnover

from retail

from other operators

Total turnover

Operating costs

CCA adjustments

Total operating costs

Return

Current
year

Prior
year

(cid:29)1

(cid:29)2

(cid:29)3 =(cid:29)1 –(cid:29)2

The calculation of the return must be consistent with the basis on which the cost of capital is calculated.
Therefore, if — as envisaged in the main body of the guidelines — a pre-tax and pre-interest WACC is
used, the return shown in the accounts should be equivalent to profit before interest and tax.

(b) Balance sheet information

Current
year

Prior
year

Fixed assets

Tangible fixed assets

Intangible fixed assets

Investments

Total fixed assets

Current assets

Stocks

Debtors

Investments

Cash at bank and in hand

Total current assets

Creditors

Provisions
charges

for

liabilities

and

Mean capital employed

(cid:29)1

(cid:29)2

(cid:29)3

(cid:29)4

(cid:29)5 =(cid:29)1 +(cid:29)2 –(cid:29)3 –(cid:29)4

All entries in the ‘balance sheet’ should be prepared on a current cost basis. They should be average
values for the year to which they relate. Where possible and material the average values shown should
be weighted averages. If information is not available, a simple average of opening and closing balances
may initially be used.

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13. 5. 98

(c) Return on capital employed

Return

Mean capital employed

Return on mean capital employed (%)

Current
year

Prior
year

(cid:29)1

(cid:29)2

(cid:29)3 =(cid:29)1 /(cid:29)2

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Figure 7.2.

Suggested reporting formats for the local access network business

(a) Profit and loss

Current
year

Prior
year

Turnover

Transfer charges to retail

From other operators (if any)

Total turnover

Operating costs

CCA adjustments

Total operating costs

Return (excluding ADCs, if any)

ADCs (if any)

from other operators

from retail

Total ADCs

Return (including ADCs, if any)

(b) Balance sheet information

As for core network.

(c) Return on capital employed

As for core network.

(cid:29)1

(cid:29)2

(cid:29)3 =(cid:29)1 –(cid:29)2

(cid:29)4

(cid:29)5 =(cid:29)3 +(cid:29)4

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13. 5. 98

Figure 7.3.

Suggested reporting formats for the retail business

Current
year

Prior
year

(a) Profit and loss

Turnover:

Connection charges

Rental charges

Call charges

Other turnover

Total turnover

Operating costs:

Operating costs specific to retail

Transfer charges from core network

Transfer charge from local access network

ADCs paid to local access network (if any)

CCA adjustments

Total operating costs

Return (excluding universal service contributions,
if any)

Universal service contributions from other oper-
ators (if any) (1)

Return (including universal service contributions,
if any)

The same formats would apply to separate regulated activities within retail.

(b) Balance sheet information

As for core network.

(c) Return on capital employed

As for core network.

(cid:29)1

(cid:29)2

(cid:29)3 =(cid:29)1 –(cid:29)2

(cid:29)4

(cid:29)5 =(cid:29)3 +(cid:29)4

(1) Universal service contributions applied internally would net off to zero and are therefore not shown in the profit and loss

for retail.

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Figure 7.4.

Suggested reporting formats for ‘other activities’

Current
year

Prior
year

(a) Profit and loss

Turnover

Operating costs

Return

(cid:29)1

(cid:29)2

(cid:29)3 =(cid:29)1 –(cid:29)2

As discussed in the main body of the guidelines there may be a case for disaggregating ‘other activities’
in order to provide greater transparency of the performance of specific activities. It will be up to indi-
vidual NRAs to specify the extent to which separate accounts for these activities will be prepared.

(b) Balance sheet information

As for core network.

(c) Return on capital employed

As for core network.

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13. 5. 98

Appendix

Current cost accounting

1. Calculation of current cost asset values

A key element of the current cost methodology is the valuation of assets. Assets could be valued according to
the following considerations and decision rules:

Net replacement cost

The net replacement cost is the cost of replacing the asset with another asset of similar characteristics and
age.

A key element of this formula is the calculation of the replacement cost of the asset. Replacement cost can
simply be the cost today of replacing the asset with an identical one. However, when technology is changing
rapidly, the existing asset may no longer be replaceable (e.g. it is no longer manufactured). In this case it is
necessary to calculate the modern equivalent asset (‘MEA’) value which is the value of an asset with the same
level of capacity and functionality as the existing asset. The issues relating to the calculation of MEA values
for telecommunications operators are considered further below.

Deprival value

Deprival value (‘DV’) represents the recoverable value of the asset to the organisation; that is, the higher of
the economic value the asset is likely to generate or the net realisable value (‘NRV’) of the asset if it were
sold.

Economic value

Economic value (‘EV’) is a measure of the value of an asset based on the net present value of future cash
flows.

The valuation rules can be summarised as follows:
— if EV ; NRV, the company will keep the asset in its current use,
— if NRV ; EV, the company will sell the asset now as the proceeds from the sale would exceed the

economic value that it would be expected to generate from its continued use.

Therefore the deprival value or recoverable amount of the asset is the higher of EV and NRV. The current
cost therefore is the lower of its deprival value and the net replacement cost. That is, the lower of the amount
the company could recover from the asset and the cost to the company to replace the asset with an identical
one.

2. Modern equivalent asset valuation issues

The adoption of CCA methodologies in telecommunications is complicated by the rate of technological
change in the industry. This has implications in both identifying suitable replacement costs for old techno-
logy assets and ensuring the assets exhibit the same levels of functionality and capability.

Examples of technological issues for telecommunications operators include:

— copper versus fibre cables,

— analogue versus digital switches, and

— PDH transmission technology versus SDH technology.

The new technologies are usually far superior to the old technologies in terms of functionality and efficiency.
However, since MEA values are required to reflect assets of equivalent capacity and functionality, it is neces-
sary to make adjustments to the current purchase price and also the related operating costs — for example,
the new asset may require less maintenance.

3. Current cost accounting adjustments

There are two alternative approaches to CCA. The approaches differ in their approach to ‘capital main-
tenance’. That is, the manner in which the capital of the company is viewed when determining profit.

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Capital can either be viewed in operational terms (i.e. as the company’s capacity to produce goods and
services) or in financial terms (i.e. as the value of shareholder’s equity interest). These are known as operating
capital maintenance and financial capital maintenance concepts respectively:

— operating capital maintenance (‘OCM’) considers the operating capability of the company. Proponents of
OCM assert that capital maintenance under this approach requires the company to have as much oper-
ating capability — or productive capacity — at the end of the period as at the beginning (1),

— financial capital maintenance (‘FCM’) considers the financial capital of the company is maintained in
current price terms. Capital is assumed to be maintained if shareholders’ funds at the end of the period
are maintained in real terms at the same level as at the beginning of the period (2).

3.1. The main adjustments under OCM

As set out above, this concept is concerned with the maintenance of the productive capacity of the operator.
One of the signification adjustments relates to the revaluation of fixed assets to current cost. Due to this
revaluation additional adjustments are then required to restate depreciation amounts. These are identified
below.

Revaluation of fixed assets

Under OCM the gross book value of assets is revalued to take account of specific price changes in the price
of assets and changes in technology.

One way of calculating the current cost of assets is to apply specific price indices to the existing gross book
value of assets. These may be derived from the company’s procurement department. Alternatively, modern
equivalent asset (‘MEA’) valuation methods may be used. These base the value of assets on the current cost of
modern equivalent assets subject to cost ‘abatements’. These abatements are discussed further below.

Supplementary depreciation

The depreciation charge for the year is calculated on the basis of the new asset valuations. This ensures that
the current cost of fixed assets consumed during the year is charged against revenue. For each asset, or group
of assets, the OCM depreciation charge — assuming straight line depreciation — can be derived by dividing
the gross replacement cost by asset life.

Supplementary depreciation is the difference between historical cost depreciation and current cost depreci-
ation charge. It may be positive or negative depending on whether the value of assets is rising or falling. It is
a charge against profits in the profit and loss account.

Illustration of these concepts

The tables below illustrate the above concepts for an asset purchased for ECU 10 000. The assumed life of
the asset is four years. For simplicity, it is assumed that the asset is depreciated on a straight line basis. In
Table 1 it is assumed that the cost of replacing the asset falls by 10 % per annum. Table 2, on the other
hand, assumes that the cost of replacement increases by 5 % per annum.

Table 1

Replacement cost falling by 10 % per annum

Depreciation

Year

Current
Cost

Current
cost

Historical

Supplementary

Cumulative

‘Required’

Backlog

0

1

2

3

4

10 000

9 000

8 100

7 290

6 561

2 250,00

2 500,00

2 025,00

2 500,00

1 822,50

2 500,00

1 640,25

2 500,00

(250,00)

(475,00)

(677,50)

(859,75)

2 250,00

2 250,00

Nil

4 275,00

4 050,00

5 872,50

5 467,50

7 107,75

6 561,00

(225,00)

(405,00)

(546,75)

(1) In efficient terms and in a long-run approach.
(2) For the capital as employed by an efficient operator.

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Table 2

Replacement cost rising by 5 % per annum

Year

Current
Cost

Current
cost

Historical

Supplementary

Cumulative

‘Required’

Backlog

Depreciation

0

1

2

3

4

10 000,00

10 500,00

2 625,00

2 500,00

125,00

2 625,00

2 625,00

Nil

11 025,00

2 756,25

2 500,00

256,25

5 381,25

5 512,50

131,25

11 576,25

2 894,06

2 500,00

394,06

8 406,56

8 682,19

275,63

12 155,06

3 038,77

2 500,00

538,77

11 720,96

12 155,06

434,10

Derivation/explanation:

— current cost is the gross replacement cost of the asset,

— current cost depreciation is derived as the gross replacement cost divided by the asset life,

— historical cost depreciation is the original acquisition cost divided by the asset life,

— supplementary depreciation is the additional depreciation charged as a result of revaluing the asset (it can also be derived

as current cost depreciation less historical cost depreciation),

— cumulative depreciation is the sum of cumulative current cost depreciation as at the end of the previous period, backlog
depreciation for the previous period and current cost depreciation for the current period. This is equivalent to required
depreciation at the end of the previous plus current cost depreciation for the current period,

— ‘Required’ depreciation is the cumulative depreciation that would have been charged given the current cost of the asset

— put another way, it is the difference between the gross and net replacement cost of the asset, and

— backlog depreciation is the difference between required depreciation and cumulative depreciation.

3.2. Further adjustments under financial capital maintenance (FCM)

Under FCM there are similar adjustments to be made as in the OCM concept concerning the revaluation of
fixed assets and supplementary depreciation. However, under FCM some of the treatments in terms of profit
and loss need to be further adjusted to take into account of holding gains or losses that arise due to the effect
of asset-specific inflation on the current cost value of assets and the effect of general inflation on share-
holders’ funds (1).

4. Which capital maintenance concept?

The above discussion has set out the main adjustments required to historical cost accounts in order to derive
current cost information using OCM and FCM. It has been included to reflect the fact that the transition to
LRAIC from fully allocated historical costs as the basis for determining interconnection charges requires that
assets are valued at their market value (or current cost). The use of current cost information is therefore a key
aspect in helping to determine appropriate interconnection charges and special attention should be provided
to the choice of capital maintenance as employed by an efficient operator (2).

(1) The Arthur Andersen report on accounting separation in the context of ONP provides further guidance on the accoun-

ting adjustments to be provided under financial maintenance concept.

(2) Subject to the level of investment in assets being efficient.

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If OCM was used to determine charges, the revenue requirement (1) would be derived as the sum of operating
costs, historical cost depreciation, supplementary depreciation and a return on net assets. Under FCM, the
revenue requirement would be the sum of operating costs, historical cost depreciation, supplementary depre-
ciation and a return on net assets less holding gains/losses plus the adjustment to shareholders’ funds.
Required revenue therefore differs depending on the capital maintenance concept used.

The use of the OCM concept may systematically incorporate insufficient or excess returns into the level of
allowed revenue (depending, respectively, on whether asset-specific inflation was expected to be lower than
or higher than general inflation). This is not a desirable feature of any regulatory regime, as it would not
provide appropriate investment incentives. Therefore FCM is the preferred capital maintenance concept.

(1) Defined as the level of revenue required in order to earn a reasonable return.