One thing that anybody who builds a fiber network needs to deal with at some point is depreciation expense. Fiber networks are expensive and depreciation expense is a key component for measuring profitability and success. This is even true for non-taxable entities if you still create financial reports that include depreciation.
Companies differ in their approach to depreciating their assets. If the owner is a taxable corporation or cooperative they may prefer higher depreciation expense in the early years to shield the business from income taxes. But other owners care a lot about what their financial reports say and I know some fiber network owners that like lower depreciation. Accountants all understand that depreciation is a non-cash expense, but this is a nuance that is often lost on the public or the non-sophisticated reader of financial statements.
My job allows me see the books of a lot of different kinds of telecom entities and I see that depreciation rates used for telecom assets vary widely. There was a time when the FCC and state commissions set depreciation rates for big companies, and the rest of industry usually followed. But today a fiber provider is free to set depreciation lives within a surprisingly wide range.
There is only one authoritative source for depreciation lives which is from a bulletin published by the IRS in 2015. That bulletin establishes a baseline for depreciation for tax purposes for fiber networks that assumes a conservative and short life for fiber assets. For example, the IRS life for fiber cable is 24 years. At the other end of the scale, I have clients who are using a 40-year life on fiber. From an accounting perspective this wide range is like night and day.
In my experience the economic lives suggested by the IRS are ridiculously short. There was a time in the 1980s when a 20 to 25-year life for fiber was probably reasonable. The early generations of fiber cable had manufacturing flaws that allowed small cracks to develop over time that eventually cause the fiber to become opaque and lose usefulness. Most of the fiber built in those days has deteriorated over the years and has been retired or is of limited use today.
But the manufacturing process for fiber cables has improved drastically in each succeeding decade. I’ve talked to engineers at the fiber manufacturers who estimate that today’s fiber cables might easily last for 50 to 75 years as long as it’s installed properly and not unduly stressed. And there is speculation that fiber might last even longer – we’ll just have to wait and see.
The same thing is true for fiber electronics. Thirty years ago electronics in general were not as well made or as robust as today. There were large clunky circuit cards that expanded and shrunk in outside use and then eventually went bad. And these cards were full of individual components that could fail. But today a lot of the brains of electronics is embedded in chips that can last for a long time.
I can remember back in the 1990s when the engineering mantra was that you designed electronics to last from 7 to 10 years. Within that time frame the equipment would either start having operational issues or else the manufacturer would stop supporting it. But today’s electronics are much hardier and more reliable. I have several clients that still operate the first generation BPON fiber network networks. The electronics on these networks were made 12 – 15 years ago and are still going strong, and during that time they have had almost no failures. But most companies used depreciation lives for the BPON electronics of between 7 to 10 years. The same thing is true with the electronics used to power backbone networks. I have clients still operating networks built 15 years ago at twice the expected economic life.
So my advice to clients is that if they they are not stuck with whatever deprecation rates they are using. If they have reasons to might want shorter or longer depreciation lives there might be a justification for changing the depreciation rates. When I first got into the industry everybody used rates within a narrow range, but today there is a huge amount of flexibility in settling depreciation rates.
If your financial statements are audited then your auditor might want a professional opion of why it’s okay to change rates. But there is a huge amount of empirical data to support using longer lives for both fiber and electronics. And if you want to shorten lives it’s fairly easy to point to the IRS rules.
Accounting is not supposed to be this flexible and one would expect the industry to have a more consistent range of depreciation practices. But once the regulators stepped out of the business of regulating depreciation lives it’s been the wild west from an accounting perspective. So if you don’t like what depreciation expense is doing for you, contact me and I can help you find a better answer.