Download 1.4 Flow of TD-LRAIC modelling

ERNST & YOUNG BALTIC UAB
Ryšių reguliavimo tarnyba
Reference paper for creating top down long run average incremental cost model
(non binding English translation)
2005, June 13
Table of contents
1
INTRODUCTION ............................................................................................................4
1.1
1.2
1.3
1.4
1.5
2
SCOPE OF THE MODEL .................................................................................................4
DIVISION OF CORE AND ACCESS NETWORKS...............................................................4
BASIC PRINCIPLES IN LRAIC ......................................................................................5
FLOW OF TD-LRAIC MODELLING ..............................................................................5
STRUCTURE OF THE DOCUMENT .................................................................................6
VALIDATION OF MODEL ASSUMPTIONS..............................................................7
2.1
RULES FOR ESTABLISHING LIST OF HCC ....................................................................7
2.1.1
Distinction between operating expenditure and capital expenditure ................7
2.1.2
CAPEX related HCC ..........................................................................................8
2.1.3
OPEX related HCC ..........................................................................................10
2.1.4
Common remarks..............................................................................................10
2.1.5
List of principles ...............................................................................................11
2.2
RULES FOR ESTABLISHING NETWORK ELEMENTS .....................................................13
2.2.1
Core network ....................................................................................................13
2.2.2
List of network elements ...................................................................................14
2.2.3
List of principles ...............................................................................................15
2.3
RULES FOR ALLOCATION SCHEME ............................................................................16
2.3.1
Separation of Independent and dependent HCC’s ...........................................16
2.3.2
Allocation of independent HCC .......................................................................19
2.3.3
Allocation of dependent HCC...........................................................................19
2.3.4
Specific cases ....................................................................................................20
2.3.5
Allocation of costs of transmission network.....................................................20
2.3.6
Allocation of costs of switching network ..........................................................20
2.3.7
List of principles ...............................................................................................21
2.4
RULES FOR CONSTRUCTING COST VOLUME RELATIONSHIPS ....................................23
2.4.1
Cost concepts ....................................................................................................23
2.4.2
Shapes of CVR curves.......................................................................................24
2.4.3
Deriving CVR shapes .......................................................................................26
2.4.4
Verification of CVR shapes ..............................................................................27
2.4.5
List of principles ...............................................................................................28
3
COST MAPPING ...........................................................................................................30
3.1
RECONCILIATION OF INPUT TO PROFIT AND LOSS STATEMENT .................................30
3.1.1
OPEX reconcilation .........................................................................................30
3.1.2
CAPEX reconcilation .......................................................................................31
3.1.3
List of principles ...............................................................................................32
3.2
RECONCILIATION OF INPUT TO BALANCE SHEET.......................................................32
3.2.1
Basics................................................................................................................32
3.2.2
Reconcilation of fixed assets ............................................................................33
3.2.3
Classification of working capital .....................................................................33
3.2.4
List of principles ...............................................................................................36
4
CURRENT COST ACCOUNTING ..............................................................................38
4.1
ASSET REPLACEMENT METHOD ................................................................................39
4.1.1
Application of SAPI ..........................................................................................39
4.1.2
Application of DAR ..........................................................................................40
4.1.3
List of principles ...............................................................................................41
4.2
NETWORK REVALUATION AND ADJUSTMENT ...........................................................42
2
4.2.1
Modern equivalent asset...................................................................................42
4.2.2
Modern equivalent asset in switching network ................................................43
4.2.3
Modern equivalent asset in transmission network ...........................................43
4.2.4
Impact of modern equivalent assets on other costs ..........................................45
4.2.5
Capacity and equipment optimization ..............................................................45
4.2.6
List of principles ...............................................................................................46
4.3
MAPPING OF INVESTMENTS ......................................................................................47
4.3.1
List of principles ...............................................................................................48
4.4
CALCULATION OF HOLDING GAIN AND BACKLOG DEPRECIATION ............................49
4.4.1
List of principles ...............................................................................................53
4.5
REVALUATION OF OPERATING EXPENDITURES .........................................................54
4.5.1
List of principles ...............................................................................................55
4.6
REVALUATION OF WORKING CAPITAL ......................................................................55
4.6.1
List of principles ...............................................................................................55
5
ROUTING MATRIX .....................................................................................................56
5.1
CALCULATION OF TOTAL CALL ATTEMPTS ...............................................................56
5.2
CALCULATION OF TOTAL MINUTES ...........................................................................57
5.2.1
Set A of routing matrixes ..................................................................................57
5.2.2
Set B of routing matrixes ..................................................................................59
5.3
CALCULATION OF AVERAGE NUMBER OF NETWORK ELEMENTS...............................62
5.3.1
Set A of routing matrixes ..................................................................................62
5.3.2
Set B of routing matrixes ..................................................................................63
5.4
LIST OF PRINCIPLES ..................................................................................................64
6
REQUIREMENTS FOR MODEL FUNCTIONALITY .............................................66
7
APPENDIX NO. 1. CALCULATING COST OF LEASED LINES ..........................67
7.1
7.2
GENERAL SECTION ....................................................................................................67
LIST OF PRINCIPLES ..................................................................................................71
8 APPENDIX NO. 2. CALCULATING COST OF POINT OF
INTERCONNECTION ..........................................................................................................72
8.1
PHASE ONE ................................................................................................................72
8.2
PHASE TWO ...............................................................................................................73
8.3
NUMERICAL EXAMPLE .............................................................................................74
8.3.1
Providing capacity for IC link (one-time fee) ..................................................74
8.3.2
Providing capacity for IC link (monthly costs) ................................................74
9 APPENDIX NO. 3. CALCULATING COST OF CARRIER SELECTION,
CARRIER PRESELECTION AND NUMBER PORTABILITY ......................................76
9.1
PHASE ONE ................................................................................................................76
9.2
PHASE TWO ...............................................................................................................77
9.3
NUMERICAL EXAMPLE .............................................................................................77
9.3.1
Set-up costs .......................................................................................................77
9.3.2
Consumption costs ............................................................................................79
3
1
INTRODUCTION
1.1 Scope of the model
The purpose of this document is to provide guidelines for building top-down long run
average incremental cost (TD-LRAIC) model to estimate fixed line voice interconnection
services. Interconnection services that are covered in this document comprise:
 call set-up;
 call origination;
 call termination;
 call transit.
Guidelines for calculating LRAIC costs for providing leased lines services are presented in
appendix 1.
Guidelines for calculating costs of point of interconnection are provided in appendix 2.
Guidelines for calculating costs of additional core network services are provided in appendix
3.
1.2 Division of core and access networks
Fixed line telecomunnications network consist of core and access networks. Access network
connects subscriber to core network. Core network switches and transmits traffic that is
generated by subscribers.
Scheme 1. Fixed line network structure
Fixed line network
Access network
Cables
Ducts
Subscriber
units
Core network
Line cards
Switches
Multiplexers
Cables
Power plant
According to LRAIC methodology it is important to distinguish between subscriber and
traffic driven parts of the network. The costs of access network elements are driven by the
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number of subscribers while the costs of core network elements are driven by the traffic
generated by subscribers. Normally line card which is part of subscriber unit constitues
boundary between the core and access networks. The scope of the LRAIC model is the core
network – interconnection costs are determined by costing core network elements that are
needed to provide interconnections services.
1.3 Basic principles in LRAIC
All calculations in model are based on long run average incremental cost (LRAIC)
methodology. The principle of average incremental costs involves estimating a change in
costs which is caused by the provision of defined increment and allocating estimated costs to
to one unit of service. Incremental costs for interconnection service can be defined as costs
that can be avoided if interconnection service were no longer be provided1. In the short
incremental costs can de split into fixed and variable incremental costs, however, in the long
run all costs are variable, which is the principle of LRAIC.
There are two different approaches while creating long run average incremental cost models
– “top down” (TD) approach and “bottom-up” (BU) approach. Objective of TD-LRAIC is to
define the costs that operator would incur using current network structure but accordingly
with demand optimised network equiment and support (network optimisation issues in detail
are adressed in section 4.2).
1.4 Flow of TD-LRAIC modelling
The fundamental principle of LRAIC models – costs are allocated to network elements,
network elements are mapped with network services and in this way interconnection costs are
calculated.
Scheme 2. Basic flow in TD-LRAIC model
Cost categories
Network elements
Services
The process of TD-LRAIC modelling and its main stages are presented below:
1
In international literature the concept of decremental costs can be used, which in pirnciple is the same
as incremental cost.
5
Scheme 3. TD-LRAIC model steps
List of cost
categories
List of network
elements
Cost allocation
scheme
Mapping of
financial data into
LRAIC model
Current cost
accounting
Network
optimisation
Routing matrix
Interconnection
costs
First step involves deriving list of homogenous cost categories, network elements and
determining cost allocation scheme. Second step requires mapping financial data into LRAIC
model. Third step involveds revaluation of financial statement items using current cost
accounting methodology and optimisation of operators core network. Finally, interconnection
costs are determined with the help of routing matrix.
1.5 Structure of the document
The document is divided into four parts:

chapter 2 describes model assumptions - rules for establishing HCC, rules for
establishing network elements, rules for allocation scheme, rules for constructing
cost-volume relationships, cost calculation;

chapter 3 describes the principles of cost mapping - reconciliation of input to profit
and loss statement, reconciliation of input to balance sheet, classification of working
capital, mapping of investments;

chapter 4 relates to current cost accounting - application of different types of
revaluation methods, application of MEA, calculation of holding gain and backlog
depreciation;

chapter 5 relates to routing matrix - validation of routing matrix and routing factors;

chapter 6 describes requirements for TD-LRAIC model functionality;

appendix 1 describes cost calculation principles for leased lines services;

appendix 2 describes cost calculation principles for point of interconnection;

appendix 3 describes cost calculation principles for additional core network services;

appendix 4 defines terms used in this document.
6
2
VALIDATION OF MODEL ASSUMPTIONS
2.1 Rules for establishing list of HCC
Homogenous cost category (HCC) is a set of costs, which have the same driver, the same cost
volume relationship (CVR) pattern and the same rate of technology change.
List of HCCs is unique for every single telecom operator – it depends on operators financial
system used and peculiarities of accounting principles. General features that could
characterize an optimal list of HCCs are presented below.
2.1.1 Distinction between operating expenditure and capital expenditure
In TD-LRAIC model we distinguish between:

capital expenditure related costs (CAPEX);

operating expenditure related costs (OPEX).
Scheme 4. Costs in TD-LRAIC model
TD-LRAIC
costs
CAPEX
Depreciation
OPEX
ROI
Salaries
Short term expenditures
Materials
External services
Long term expenditures
CAPEX costs are cost of capital (ROI), depreciation and other fixed assets related costs.
OPEX costs consist of salaries (including social insurance), material and costs of external
services (external services – transportation, security, utilities, payments to other operators,
etc) Alternatively, OPEX costs are all operational costs except depreciation and ROI. OPEX
costs are linked to costs related to short-term expenditures, while CAPEX related costs are
linked to costs related to long-term expenditures. Therefore an optimal list of HCCs should
have separate HCCs for OPEX related costs and separate HCCs for CAPEX related costs.
7
2.1.2 CAPEX related HCC
CAPEX costs are depreciation and ROI. Depreciation represents decline of value of assets
over a period of time, ROI represents cost of capital which is tied in company’s assets.
To distinguish between ROI and depreciation the operators usually set different HCCs for
cost of capital and depreciation related to the same fixed assets. In this case list of HCCs
related to cost of capital of fixed assets has to be mirrored by the list of HCCs related to
depreciation of fixed assets. It has to be noted that not all fixed assets bear the cost of
depreciation. List of fixed assets that bear no depreciation is set by Lithuanian law.
List of fixed assets should be grouped as described in the scheme below:
Scheme 5. Grouping of fixed assets
Fixed assets
Network related
fixed assets
General fixed
assets
Access network
fixed assets
Core network fixed
assets
Common fixed
assets
Interconnection
related fixed
assets
Other service
related fixed
assets
Common fixed
assets
Fixed assets can be classified into network related fixed assets and general fixed assets
(office building, fixtures and fittings, vehicles). Network related fixed assets can be classified
into access network fixed assets (cables, distribution frames), core network fixed assets and
fixed assets that are common to core and access networks (cables, subscriber units). Core
network fixed assets can be classified into telecommunications equipment, which is directly
used in providing interconnection services (switches, multiplexers), other service related
fixed assets, which is directly used in providing other core network services (i.e. dedicated
data transmission systems) and telecommunications equipment, which is common to several
core network services (i.e. transmission network equipment).
8
List of HCCs of fixed assets should be grouped into:

Interconnection related core network fixed assets;

Other service related core network fixed assets;

Core network fixed assets common to several services;

Network related fixed assets common to core and access network;

General fixed assets.
List of HCCs should be defined for at least the following group of assets:

cables;

multiplexers;

other transmission network equipment;

remote subscriber units;

colocated subscriber units;

local switches;

transit switches;

international switches;

other switching network equipment.
In addition it has to be noted that particular fixed assets of identical functionality differ in
terms of cost volume relationship patterns or even cost drivers. Switches of two different
suppliers may have two different cost-volume relationships (CVRs), likewise switches of two
different hierarchical levels for example local switch or primary switch. From this
perspective every properly defined list of HCCs should have separate HCCs for:

technologically diverse assets (i.e. different HCC for copper cables and optical
cables, different HCC for EWSD, AXE or 5ESS switches etc.);

hierarchically diverse assets (i.e. different HCC for local switches and primary
switches, different HCC for access cables and long-distance cables).
Dividing HCCs for technologically and hierarchically diverse assets is needed in order to
make proper revaluation of fixed assets. Revalualion process itself is presented in detail in
chapter 4.
9
2.1.3 OPEX related HCC
OPEX costs are all operational costs except depreciation and ROI . OPEX costs include:

salaries including social insurance;

materials;

external services (transport, utilities, etc);
Every telecommunication operator should distinguish between these activities:

retail;

core network management ;

supporting .
Retail activities are related to transforming and selling wholesale products or services to end
customers encompassing marketing, distribution and customer care. . Core network
management
activities are related to operation and maintenance of network assets.
Supporting activities are related to any activities that support core activities of the operator
(i.e. marketing or network), like accounting, human resources, administration, asset
management etc.
Scheme 6. OPEX costs
OPEX
Core network
management
Retail
Materials
Salaries
External
services
Materials
Supporting
External
services
Salaries
Materials
Salaries
External
services
Due to their different functions it is very unrealistic that some retail, network or supporting
activities would be homogenous in drivers, cost volume relationship and time changes in
technology. Therefore cost of retail, network or supporting activities should be allocated to
different HCCs.
2.1.4 Common remarks
The scope of LRAIC model is network elements that are used to provide interconnection
services. On the other hand, HCC list should consist of HCCs that are related to
10
interconnection services and HCCs that are not related to interconnection services. HCCs,
that are not related to interconnection services by no means can be allocated to network
elements that are used to provide interconnection services. In any case, there are several
reasons to have a list of HCCs not related to interconnetion services. First, this will simplify
the allocation process of dependend and independent HCCs (this issue is adressed in section
2.3). Second, it will simplify the reconcilation of LRAIC data with financial statements.
It is important to ensure that payments made to other operators for calls originated or
terminated in their networks, fixed asset write-offs and inventory write-offs by no means can
be included into calculations of interconnection costs.
It has to be stressed that an optimal structured list of HCCs has to be characterized by well
distribution between different HCCs. Ussualy HCC list holds around 200 to 400 HCCs. At
maximum one HCC should contain around 5% of total costs, whereas most HCCs should
concentrate less than 1% of total costs. HCCs for “other costs” should not represent more
than 3% of all costs. If so, they should be broken down into more detailed HCCs.
2.1.5 List of principles
1. Define separate HCCs for OPEX and CAPEX related cost (obligatory).
2. Define separate HCC for working capital and fixed assets related cost (obligatory)
3. Define separate HCCs for ROI and depreciation related to the same fixed asset
(obligatory).
4. List of HCCs of fixed assets should be grouped into (obligatory):

Interconnection related core network fixed assets;

Other service related core network fixed assets;

Core network fixed assets common to several services;

Network related fixed assets common to core and access network;

General fixed assets.
5. List of HCCs should be defined for at least the following group of assets
(obligatory):

cables;

multiplexers;

other transmission network equipment;
11

remote subscriber units;

colocated subscriber units;

local switches;

transit switches;

international switches;

other switching network equipment.
6. Define separate HCCs for technologically diverse switches (obligatory).
7. Define separate HCCs for copper cables and fiber optic cables (obligatory).
8. Define separate HCCs for retail, network and supporting activities (obligatory).
9. Ensure that one HCC does not concentrate more than 5% of total costs. Most of the
HCCs should concentrate less than 1% of total costs (recommended).
10. Ensure that HCC for “other costs” does not represent more than 3% of total costs
(obligatory).
11. Optimal list should consist of around 200 to 400 HCC (recommended).
12. HCCs not related to interconnection services network cannot be included in
interconnection cost calculations (obligatory).
12
2.2 Rules for establishing network elements
2.2.1 Core network
Core network consist of different network elements. Network element is an object,
equipment, hardware or software that logically or physicaly can be identified as independent
network unit (segment).
Scheme 7. Structure of fixed line telecommunications network
International
switch
Core
network
Transit switch
Transit switch
Switching
network
Transmission
network
Local switch
Local switch
Local switch
Local switch
Remote
subscriber unit
Remote
subscriber unit
Remote
subscriber unit
Remote
subscriber unit
Subscriber
Subscriber
Subscriber
Subscriber
Subscriber
Subscriber
Access
network
Subscriber
Core network consists of switching and transmission networks. Switching network consists
of switches and related equipment that ensures switching of and termination of calls among
end points of the network. Transmission network consist of equipment, ensuring transmission
of electric and optic signals among different network elements. In other words,
telecommunication networks represent a kind of hierarchy. Such network hierarchy consists
of nodes (i.e.: in fixed-telephony core network nodes are switches) and paths between them
(i.e.: transmission links in fixed-telephony core network).
Network nodes can be grouped into these categories:

subscriber unit;

local switch;

transit switch;

international switch.
13
Subscriber unit separates access and core network. Subscriber units are functional units
providing access to subscribers (via line card) on one hand and access to switching host (via
2Mbps ports) on the other. Subscriber units may be co-located or remotely located to a
switch. Costs of subscriber unit are allocated partly to access and partly to core network (cost
allocation is described in section 2.3.6).
2.2.2 List of network elements
From the perspective of cost calculation of interconnection services only newtork elements
(NE) representing fixed-telephony core network are of interest.
On the other hand list of NE may include network elements not related to interconnection
services. HCCs, which cannot be mapped to interconnections services will be allocated to
these network elements.
From LRAIC perspective, network elements is understood as a logical elements that may be
different from physical network elements. For example, one physical network element
subscriber unit could be split into two logical network elements: “part of switch driven by
traffic” and “part of switch driven by a number of subscribers”. In consequence the list of
NEs in LRAIC model should consist at least of:

subscriber units;

local switches;

transit switches;

international switches;

signalling;

transmission link between remote concentrators units and local switches;

transmission link between local and transit switches

transmission link between and local and local switches;

transmission link between local swiches and other network;

transmission link between transit switches and international switches;

transmission link between transit switches and transit switches;

transmission link between transit switches and other network;

wholesale specific cost;
14

wholesale billing systems.
The above list of network elements can be grouped into call set-up related NEs and call
duration related NEs. Call set-up related group of NEs consist of Signaling and Wholesale
billing systems which cost is driven by busy hour call attempts (BHCA). Call duration related
group of NEs consist of remaining network elements which cost is driven by busy hour traffic
(BHT). The essential step in calculation separate fee for call set-up is the separation of switch
cost between defined NE that is described in details in section 2.3.6.
Additionally list of NEs can be extended by any new NE. The new NE could be created
mainly in order to calculate cost of providing regulated supplementary services. The
presented list of NE could be extended by specific NE related to Preselection, Number
Portability and other. It should be noticed that top-down approach has some limitations
concerning the granularity of the NE. Increasing extensively the number of NE by specific
network components will result in less accuracy in cost allocation and furthermore in cost
calculation.
2.2.3 List of principles
1. Ensure that the list of NEs consists at least of (obligatory):

subscriber units;

local switches;

transit switches;

international switches;

signaling;

transmission link between remote concentrators units and local switches;

transmission link between local and transit switches

transmission link between and local and local switches;

transmission link between local swiches and other network;

transmission link between transit switches and international switches;

transmission link between transit switches and transit switches;

transmission link between transit switches and other network;

wholesale specific cost;
15

wholesale billing systems.
2.3 Rules for allocation scheme
Allocation scheme is a set of rules determining how homogenous cost categories are
allocated to NEs.
2.3.1 Separation of Independent and dependent HCC’s
The first step in setting the allocation scheme is to decide which HCCs are independent and
which are dependent. A HCC is called independent when its cost driver is exogenous. An
example of an independent HCC can be cost of transmission multiplexer. The cost driver of
transmission multiplexer HCC is number of 2Mbps circuits – the larger the volume of 2
Mbps circuits the higher is the cost of transmission multiplexer. Since the number of 2 Mbps
circuits is an exogenous driver (it does not depend on the cost of any other HCC) the cost of
transmission multiplexer is an independent HCC.
A HCC is called dependent when its cost driver is a cost of another HCC. An example of a
dependent HCC can be power plant. The cost driver of power plant is power consumption of
telecommunication equipment – the larger the power consumption, the larger is the capacity
of the power plant and hence the higher is its cost. Since it is very difficult and timeconsuming to derive power consumption of individual telecommunication equipment, in
practice power consumption is proxied by cost of the equipment it powers. In consequence it
is assumed that the cost of telecommunication equipment drives the cost of power plant, or in
other words the cost of power plant depends on the cost of telecommunication equipment i.e.
on the cost of another HCC. Therefore power plant HCC is a dependent HCC.
The dependent cost categories can be further classified as first-, second- or higher-order
dependent HCCs. Since first-order dependent HCC depends on cost of independent HCCs,
therefore in order to allocate the cost of first-order dependent HCC first the cost of
independent HCC has to be allocated on NEs. Similarly in order to allocate the cost of
second-order dependent HCC first the cost of first-order dependent HCC has to be allocated
and so on. In most of models only first-order dependent categories are in use, as usage of
higher-order dependency makes calculations more cumbersome.
Circular references should be avoided while defining independent and dependent HCCs in
TD-LRAIC model. A simple example of circular reference could be a situation when firstorder dependent HCC depends on second-order dependent HCC, which depends on the same
first-order HCC. As a consequence, lower-order dependent HCC should not be dependent on
16
higher-order dependent HCC. A threat of circular reference is also eliminated when only
first-order dependent HCCs are used.
It should be noted that a number of HCCs can be defined as either dependent or independent
ones, it depends on how the driver for this HCC will be defined. If the cost driver for power
plant is defined as power consumption of individual NE then the HCC for power plant will
become independent one. However, if the cost driver for power plant is defined as cost of
other HCC allocated to individual NEs then the HCC for power plant will become dependent
one.
In theory every HCC could be defined as independent, this would however complicate the
TD-LRAIC model extremely. Defining HCC as independent or dependent is at discretion of
TD-LRAIC model developer – is he willing/able to construct appropriate engineering model
and to collect appropriate data? The lower is the number of dependent HCCs the better
testimony for TD-LRAIC model developer, a good hint is that around two thirds of all HCCs
should be independent.
In general most of HCCs related to telecommunication equipment should be independent,
while dependent HCC may prevail for network support HCCs and non-network HCCs.
HCCs that are usually independent:

cables, ducts, poles, cabinets etc. – both CAPEX and OPEX related;

switches (all hierarchical levels of switching network) - both CAPEX and OPEX
related;

transmission equipment (SDH/PDH nodes) - both CAPEX and OPEX related;

wholesale billing systems;

other
dedicated
telecommunication equipment/software
software, number portability related equipment).
HCCs that are usually dependent:

power plant;

air conditioning;

operational and management systems.

IT equipment (mainframes, PCs, LANs etc.);

vehicles;
17
(carrier
preselection

buildings (office, technical, warehouse), office equipment, fixtures;

wages and material type costs of supporting groups, like: human resource
management, legal activities, accounting and financial support or high level
management etc.
Independent HCC can be allocated to one ore several network elements. Sections 2.3.2-2.3.5
provide practical examples on principles of HCC allocation to network elements.
HCC are allocated on NE by mean of CVR, whereas CVR presents cost behavior in respect
of changing volume of cost driver. Incremental costs of HCC are allocated to NEs.
Incremental cost is measured as a decrease in cost as a result of decrease in cost driver
volume. The relationship between cost and volume is presented by CVR, which is presented
in figure 8.
Scheme 8. Cost volume relationships
cost
15% IC(C)
20% IC(B)
40% IC(A)
C
20%
B
30%
A
50%
usage
As shown on scheme 8. decreasing the volume by 50% caused by eliminating service A
results in 40% cost decrease of HCC and equals to incremental cost of service A (IC(A)).
Decreasing the volume by 30% caused by eliminating service B results in 20% cost decrease
of HCC and equals to incremental cost of service B (IC(B)). Decreasing the volume by 20%
caused by eliminating NE C results in 15% cost decrease of HCC and equals to incremental
cost of NE C (IC(C)). The sum of incremental costs IC(A) + IC (B) + IC (C) amounts to 75%
of total HCC cost. The remaining part of HCC cost constitutes common and joint cost (CJC).
CJC are the effect of economy of scope and economy of scale.
18
2.3.2 Allocation of independent HCC
Independent HCCs should be allocated in the following way:

HCC for local switches should be allocated to NE for local switch and NE for
signaling (allocation of switches is further described in section 2.3.6);

HCC for transit switches schould be allocated to NE for transit switches and NE for
signaling (allocation of switches is further described in section 2.3.6);

HCC for international switches should be allocated to NE for international switches
and NE for signaling (allocation of switches is further described in section 2.3.6);

HCC for subscriber units should be allocated to following NE: access and subscriber
units (allocation of subcriber units is further described in section 2.3.6);

HCC for transmission devices should be allocated to following NE: all hierarchical
levels of transmission, other network (allocation of transmission is further described
in section 2.3.5);

HCC for ducts and cables should be allocated to following NE: all hierarchical levels
of transmission, other network, access.
HCCs, like depreciation and ROI of the same asset should be allocated to the same NE, while
the same cost driver have to be applied.
2.3.3 Allocation of dependent HCC
The cost drivers of dependent HCC are costs of other HCCs (e.g. independent HCC). The
proportion in which these costs were allocated on NE sets the effective cost driver values,
based on which the cost of dependent HCC is alocated. Therefore allocation of dependent
HCCs is limited to the assignment of the HCCs that should drive the dependent one.
Independent HCCs that drive dependent HCC are:

for operating and management PDH and SDH systems these are CAPEX related
HCC of transmission equipment;

for operating and management switch systems these are CAPEX related HCC of
switches;

for power plant these are CAPEX related HCC of power consuming telecom assets
(transmission, switches, routers).

HR, IT, vehicles, office equipment could be driven by wages related HCCs;
19

accounting, asset management, purchasing could be driven by both OPEX and
CAPEX related HCCs.
2.3.4 Specific cases
Operators experience some specific costs, which under no circumstances should be allocated
to network elements that are used to provide interconnection services. These costs are:
payments to other operators for call termination or origination, retail, fixed assets write-offs,
current assets write-offs.
In specific cases GSM service is used to reach operator’s own remotely located customer’s in
rural areas. Payments to other operators (attributable to core network) can be included in
calculating costs of interconnection services only if GSM service is used to reach operator’s
own remotely located customers in rural areas. Payments to other operators (attributable to
access network) cannot be included in calculating costs of interconnection services.
2.3.5 Allocation of costs of transmission network
It has to be noticed that the transmission systems is used for several different services: voice
services, leased lines, data transmission. Therefore the cost driver has to be found in order to
split the cost between services. Although the SDH transmission systems operates basically at
three transmission rates STM-1, STM-4 and STM-16 the smallest homogenous rate is terms
of utilized service is 2Mbps stream (circuit). The larger the volume of 2Mbps circuits the
higher the cost of transmission systems. In such a case transmission network related HCCs
should be allocated to transmission network related NEs based on 2Mbps circuits.
2.3.6 Allocation of costs of switching network
It has to be noticed that the switch consist of cost of subscriber units and cost of switching
network.
Switching network
In order to calculate call setup fee the switching network part of the switch should be
separated between the part driven by busy hour traffic (BHT) and the part driven by busy
hour call attempts (BHCA). The switching network consists of four main components: trunk
group, switching group, SS7 signaling group and central processor group. The trunk group is
driven by BHT whereas the switching group, SS7 signaling group and central processor
group is driven by BHCA. The separation between BHT driven part and BHCA driven part
20
should be done on the level of HCCs definition (in order to fulfill the principle of
homogenous cost driver). Therefore there should be separate HCCs for BHT driven part of
the switch and BHCA driven part of the switch. The BHT driven part of the switch should be
allocated to corresponding NE for Local Switch or Transit Switch and BHCA driven part
should be allocated to NE for Signaling.
Subscriber units
The subscriber units should be allocated to NE for Access and NE for Subscriber Units. The
separation between subscriber driven part and BHT driven part should be done on the level of
HCCs definition (in order to fulfill the principle of homogenous cost driver). Therefore there
should be separate HCCs for subscriber driven part of the subscriber unit and BHT driven
part of the switch.
In order to separate the cost first the total cost of subscriber units has to be calculated.
In the second step the cost of subscriber unit has to be calculated assuming that there in no
traffic but the amount of subscribers should be frozen. The difference between total cost and
cost of subscriber unit with no traffic equals to incremental cost of BHT driven part.
In the third step the cost of subscriber unit has to be calculated assuming that there in no
subscribers but the traffic value should be frozen. The difference between total cost and cost
of subscriber unit with no subscribers equals to incremental cost of subscriber driven part.
In the fourth step common and joint costs are allocated to NE for Access and NE for
Subscriber Units by equal parts, according to the incremental cost volumes or using another
cost drivers.
2.3.7 List of principles
1. Ensure that at least two thirds of total cost of HCCs is mapped to independent HCCs
(recommended).
2. Define at least the following HCCs as independent (recommended):

cables (cables, ducts, poles, cabinets etc.) – both CAPEX and OPEX related;

switches (all hierarchical levels of switching network) - both CAPEX and OPEX
related;

transmission equipment (SDH/PDH nodes) - both CAPEX and OPEX related;

wholesale billing systems;
21

other dedicated telecommunication equipment/software (carrier preselection
software, number portability related equipment).
3. Allow the following HCCs to be dependent (recommended):

power plant;

air conditioning;

operational and management systems;

IT equipment (mainframes, PCs, LANs etc.);

vehicles;

buildings (office, technical, warehouse), office equipment, fixtures;

wages and material type costs of supporting groups, like: human resource
management, legal activities, accounting and financial support or high level
management etc.
4. Independent HCCs should be allocated in the following way (obligatory):

HCC for local switches schould be allocated to NE for local switches and NE for
signaling;

HCC for transit switches schould be allocated to NE for transit switches and NE
for signaling;

HCC for international switches should be allocated to NE for international
switches and NE for signaling;

HCC for subscriber units should be allocated to following NE: access and
subscriber units;

HCC for transmission devices should be allocated to following NE: all
hierarchical levels of transmission, other ntwork;

HCC for ducts and cables should be allocated to following NE: all hierarchical
levels of transmission, other ntwork, access .
5. Dependent HCCs that drive dependent HCC are (recommended):

for operating and management PDH and SDH systems these are CAPEX related
HCC of transmission equipment;

for operating and management switch systems these are CAPEX related HCC of
switches;
22

for power plant these are CAPEX related HCC of power consuming telecom
assets (transmission, switches, routers).

HR, IT, vehicles, office equipment could be driven by wages related HCCs;

accounting, asset management, purchasing could be driven by both OPEX and
CAPEX related HCCs.
6. HCCs related to some specific costs that under no circumstances should be allocated
to network elements (obligatory):

payments to other operators for call termination or origination;

retail;

fixed assets write-offs;

current assets write-offs.
2.4 Rules for constructing cost volume relationships
Cost Volume Relationships (CVR) are at the core of developing a LRIC model. Incremental
costing bases fundamentally on CVR concept, because CVRs:

identify all variable costs;

identify all fixed costs;

trace how individual costs vary with underlying cost drivers.
2.4.1 Cost concepts
In general costs can be divided into:

variable costs and;

fixed costs.
Variable costs (VC) are costs, which varies with the changes in output level. Fixed costs (FC)
are costs, which do not vary with the changes in output level i.e. are incurred regardless of
what output is produced.
A crucial thing, which determines if a cost can be perceived as fixed or variable one, is a time
horizon, in which costs is considered. We distinguish between short run and long run. Where
short run is a length of time in which at least one input in production process is fixed in scale.
It means that in a short run total output is limited by fixed resources. Long run is a length of
23
time in which all inputs are variable in scale. It means that in a long run the output is
unlimited as all resources are variable in scale.
Wages related to customer care can be regarded as fixed in a very short-term (let us say one
month horizon). Assuming the number of subscribers drops, the wages related to customer
care will remain at unchanged level in a very short-term since the employees are protected by
appropriate employment agreements and can not be dismissed at once. But if the time horizon
becomes longer (let say one year) the wages related to customer care can be regarded as
variable. Similar the cost of a switch can be regarded as fixed in one year time, but in longterm (i.e. in time horizon corresponding to the useful life of the switch) the cost can be
perceived as variable. If the traffic drops the switch can be replaced by new, smaller one
when the older will depreciate and so will change the cost of the switch.
It is assumed that short-term horizon correspond to one year time, while long-term horizon is
assumed to be enough long to may assume that all resources can be flexible adjusted to the
required capacity.
Incremental cost is defined as a change in cost due to a change in cost driver. The principles
of incremental cost were presented in section 2.3.1. Incremental costs can be divided to
variable incremental cost and component specific cost. In regulatory cost accounting we are
not interested in break down of incremental cost into variable incremental cost and
component specific fixed cost of an activity. Therefore, in practice, it is enough to calculate
incremental cost itself. Incremental cost is a fundamental base for all LRAIC model. Only
incremental (not total HCC) costs are allocated in TD-LRAIC model. In addition to
incremental costs part of common and joint costs are allocated to NEs and consequently to
interconnection services.
2.4.2 Shapes of CVR curves
Incremental costs of all activities do not sum up to the total cost, that operator incurs. The
reason is that there is an additional cost category of common and joint costs which are
common to several activities. Common and joint costs are costs which cannot be directly
attributed to a single activity and are the effect of economy of scale and economy of scope.
Economy of scale is a phenomenon of reduction of cost per unit resulting from increased
output, realized through operational efficiencies. Due to economies of scale the cost of
producing each additional unit falls with production increase. Economy of scope is a
phenomenon, that arises when the cost of performing multiple business functions
simultaneously proves more efficient than performing each business function independently.
24
Below we provide possible shapes of CVR curves.
Figure 1
Lt
Lt
Figure 2
Volume

Volume
Figure 1 – straight line through the origin, hence no economy of scale / scope nor
fixed costs;

Figure 2 – straight line with an intercept point indicating fixed costs and no economy
of scale / scope for variable costs.
Figure 3
Lt
Lt
Figure 4
Volume

Volume
Figure 3 – curved line through the origin. This CVR indicates on purchasing power
(convexity of line) which provide economy of scale;

Figure 4 – curved line with an interception point. This CVR indicates on fixed costs
and purchasing power (convexity of line) which provide economy of scale / scope;
25
Figure 5
Lt
Lt
Figure 6
Volume

Volume
Figure 5 – curved, concave line with or without an intercept point. This CVR
indicates that cost per unit rises with output. It would point at case contrary to
economy of scope;

Figure 6 – curved, concave line with or without an intercept point. This CVR
indicates that cost per unit rises with output. It would point at case contrary to
economy of scope.
2.4.3 Deriving CVR shapes
There are three methods commonly in use to develop a particular CVR:

engineering model;

expenditure analysis;

judgmental assessment.
CVR is derived by an engineering model if the input (cost of resources) is linked to the
output (volume of service) by a set of algorithms. These algorithms are sets of engineering
rules and engineering assumptions, that allow to model the exact capacity of
telecommunication equipment to meet a given service demand. The engineering model yields
in the best approximation of CVR shape, therefore they should be applied wherever it is
possible. In fact this method of deriving the shape of CVR is applicable only in case of the
primary telecommunication infrastructure. Supporting network infrastructure, non-network
related assets as well as operating expenditures are too complicated in their nature to be able
to dimension their costs by a limited set of objective rules. Engineering models should be
applied for:

subscriber units;
26

switches;

transmission network;

ducts and cables.
Expenditure analysis is applied to derive CVRs of OPEX HCCs. Using this method costs ere
linked to service volumes on a basis of some historic cost structure. Expenditure analysis is
characterized by best approximation of CVR shape. On the other hand, application of this
method is very limited since it can be applied only there, where the relation between input
and output is explicitly presented. It can be applied to HCC representing some external
services, like operation and maintenance of telecommunication equipment.
Where neither an engineering model nor an expenditure analysis could be applied there is
judgmental assessment in use. It is based on employees knowledge and internal assumptions
and thus it is unverifiable for external experts. Judgmental assessments prevail in case of
developing CVR for non network related fixed assets and OPEX related HCC.
2.4.4 Verification of CVR shapes
Verifying CVR shapes we ask following questions:

Are the economies of scale or economies of scope in this HCC?

Are the fixed costs significant or negligible?

Is a CVR a straight line, or a concave line, etc?
Below we provide some hints on common CVR shapes for various HCCs.
Examples of network related fixed assets HCCs could be:

switches – economy of scale resulting in convexity of line, economy of scope
resulting in large amount of fixed costs, thus Figure no. 4;

transmission equipment - economy of scale resulting in convexity of line, economy
of scope resulting in large amount of fixed costs, thus Figure no. 4;

cables – economy of scope resulting in large amount of fixed costs, no change in
respect of volume, thus straight horizontal CVR line;

power plant – no economy of scale and no economy of scope, thus Figure no. 1;
Examples of non network related fixed assets HCCs could be:

IT equipment - no economy of scale and no economy of scope, thus Figure no. 1;
27

office equipment - no economy of scale and no economy of scope, thus Figure no. 1;
Examples of OPEX network related HCCs could be:

switches operation and maintenance - economy of scale resulting in convexity of
line, economy of scope resulting in large amount of fixed costs, thus Figure no. 4;

transmission equipment operation and maintenance - economy of scale resulting in
convexity of line, economy of scope resulting in large amount of fixed costs, thus
Figure no. 4;

cables operation and maintenance - economy of scope resulting in large amount of
fixed costs, no change in respect of volume, thus straight horizontal CVR line;

power plant operation and maintenance - no economy of scale and no economy of
scope, thus Figure no. 1;
Examples of OPEX supporting HCCs could be:

related to IT support - no economy of scale and no economy of scope, thus Figure no.
1;

related to HR - no economy of scale and no economy of scope, thus Figure no. 1;

related to financial and accounting - no economy of scale and no economy of scope,
thus Figure no. 1;
2.4.5 List of principles
1. Ensure that the incremental cost is presented separately for each NE (obligatory).
2. Ensure that the common and joint cost is presented separately for each NE
(obligatory).
3. Economy of scope is common for these HCC’s (recommended):

cables - both CAPEX and OPEX related;

switches - both CAPEX and OPEX related;

transmission equipment - both CAPEX and OPEX related.
4. Economy of scale is common for these HCCs (recommended)

switches - both CAPEX and OPEX related;

transmission equipment - both CAPEX and OPEX related.
28
5. Estimate the CVR shape for HCCs with one of the three methods commonly in use
(obligatory):

engineering model – for network related HCCs both OPEX and CAPEX;

expenditure analysis – for non-pay OPEX;

judgmental assessment – for other.
29
3
COST MAPPING
It is important to ensure that data used in TD-LRAIC model is mapped with data in the
statutory financial statements. The process of cost mapping can be divided into two parts:

reconciliation of input data to profit and loss statement.

reconciliation of input data to balance sheet.
3.1 Reconciliation of input to profit and loss statement
Calculation of LRAIC requires to set the economical costs of an operator on a forward
looking and current cost base:

current costs means that cost is stated in terms of current values rather than in terms
of actual acquisition cost;

economical costs cover accounting cost reported in profit and loss account and ROI;

forward looking costs means that cost is stated in terms of approximated, future
values.
Only a part of economical costs is reported in profit and loss statement of the operator, these
are the operational costs, while the ROI, in the sense presented in the definition of
economical costs, is not reported in profit and loss statement. The ROI is calculated as
product of mean capital employed times weighted average cost of capital (WACC). The
capital employed is reported in balance sheet of the operator.
Theoretically, in profit and loss account one can distinguish between:

short-term related items - operating costs (OPEX);

long-term related items - depreciation and other fixed asset related costs (CAPEX
without ROI).
3.1.1 OPEX reconcilation
The total OPEX costs should be reconciliable with the sum of the following positions from
profit and loss statement:

costs of goods sold (position II in Lithuanian profit and loss account);

administrative costs (position IV in Lithuanian profit and loss account);
30
Depreciation costs should be eliminated from the positions that are mentioned above.
It should be noted, that OPEX are reconcilable only with a part positions in profit and loss
account. Eliminated positions in profit and loss account are:

financial activity expenditures (position VII in Lithuanian profit and loss account);

extraordinary expenses (position X in Lithuanian profit and loss account);

profit tax (position XII in Lithuanian profit and loss account).
While reconciling the operating costs related to operating expenditures it should be assured
that no fixed assets related costs are included in profit and loss account aswell.
3.1.2 CAPEX reconcilation
The historical depreciation (HD) is mapped into the LRAIC model in order to calculate the
HD/GBV ratios for individual asset related HCCs. Ideally to every fixed asset related HCC
its historic figures should be assigned. It means HD of the assets mapped into one HCC
should be assigned to this HCC.
In consequence total HD of all fixed assets related HCCs should reconcile with total HD
recorded in financial statement.
In practice the detail level of fixed asset register does not provide enough information to
assign to each HCC its historic figures one to one. In such a case for the purpose of
calculating HD/GBV ratios the HCC should be grouped into broader fixed assets categories
that can be matched with fixed asset register. Identical ratios should be applied to all HCC
falling into one of broader fixed asset categories.
The appropriate mapping is very important since methodology used for calculation of fixed
assets depreciation in TD-LRAIC model should be the same as in financial accounting. This
methodology should be aligned with Lithuanian law and reflect optimal economic decisions.
The formula for calculating current depreciation is discussed in details in section (4.3).
In practice, significant part of other fixed assets related costs are cost of fixed assets sold. It
should be stressed that the difference on cost of fixed assets sold and revenue on fixed assets
sold should correct the cost of depreciation. Is the fixed asset sold above its net book value it
give raise to assume the fixed asset has been depreciated in the company’s books too
aggressively. Therefore the resulting gain from sales of fixed assets should adjust down the
depreciation figure. Vice versa is the fixed asset sold below its net book value it means the
market value of fixed asset is less than its net book value and presumably the depreciation
31
rate was too low in the books of the company. Similarly the resulting loss from sales of fixed
assets should adjust up the depreciation figure. It should be stressed that it is not the cost of
fixed assets sold that adjust the depreciation figure, but the difference between revenue and
cost.
3.1.3 List of principles
1. Ensure that operating costs related to operating expenditures in the TD-LRAIC
model is reconcilable with sum of the following positions in profit and loss statement
(obligatory):

costs of goods sold (position II in Lithuanian profit and loss account);

administrative costs (position IV in Lithuanian profit and loss account);
Depreciation costs should be eliminated from the positions that are mentioned
above.
2. Ensure that operating cost in TD-LRAIC model does not include the following
positions in profit and loss account (obligatory):

other activities (position VI in Lithuanian profit and loss account);

financial activity expenditures (position VII in Lithuanian profit and loss
account);

extraordinary expenses (position X in Lithuanian profit and loss account);

profit tax (position XII in Lithuanian profit and loss account).
3. Ensure that the historic depreciation (HD) that are assigned to HCCs match with
corresponding figures in profit and loss account (obligatory).
4. Ensure that costs of sales of fixed asset are not included calculating interconnection
costs (obligatory).
3.2 Reconciliation of input to balance sheet
3.2.1 Basics
In balance sheet one can distinguish between:

short-term related items – current assets and current liabilities (often referred as
working capital);
32

long-term related items – fixed assets, equity and long term liabilities.
3.2.2 Reconcilation of fixed assets
The net book value (NBV) and gross book value (BGV) are mapped into the LRAIC model
in order to calculate the NBV/GBV and HD/GBV ratios for individual asset related HCCs.
Ideally to every fixed asset related HCC its historic figures should be assigned. It means
NBV and GBV of the assets mapped into one HCC should be assigned to this HCC.
In consequence total NBV and total GBV of all fixed assets related HCCs should reconcile
with total NBV and total GBV recorded in financial statement.
In practice the detail level of fixed asset register does not provide enough information to
assign to each HCC its historic figures one to one. In such a case for the purpose of
calculating NBV/GBV and HD/GBV ratios the HCC should be grouped into broader fixed
assets categories that can be matched with fixed asset register. Uniform ratios should be
applied to all HCC falling into one of broader fixed asset categories.
3.2.3 Classification of working capital
TD-LRAIC model involves estimating economic costs, which comprise:

operational costs reported in profit and loss statement of the operator;

ROI calculated as a product of mean capital employed times WACC.
Therefore calculating LRAIC of NE would require to allocate ROI on individual NEs.
Since decisions about debt finance are largely corporate decisions determined by a number of
factors, such as historical borrowing facilities, tax planning considerations and importance of
corporate treasury function, hence the debt position of the corporate may not relate
specifically to the funding requirements of individual NEs. Therefore allocation of capital
employed to individual NEs seems to be unfeasible process.
In order to make this process feasible it has to be traced what does the capital employed
finance. This can be answered by rearranging the balance sheet equation. In the balance sheet
equation we have:
Assets = Shareholders Founds + Liabilities
Or in more details:
FA  CA  E  D  CL
(1)
Where:
33

FA – fixed assets;

CA – current assets;

CL – current liabilities;

D – long term liabilities / debt;

E – equity.
Rearranging previous formula yields in:
FA  CA  CL  E  D
(2)
Since (CA – CL) is defined as working capital (WC), we have:
FA  WC  E  D
(3)
The right hand side of formula is simply one of the possible definitions of capital employed
of the operator – long term funds invested by shareholders (equity) and long term funds
invested by external providers of finances. The left side is basically its equivalent – fixed
assets and working capital employed to provide the services.
This shows that the capital employed finances fixed assets and working capital. Hence,
allocation of capital employed on NEs is equivalent to allocation of fixed assets and working
capital on the NEs.
Working capital is by definition current assets less current liabilities, the definition however
evokes in practice much controversy. It is often not so clear which items should be regarded
as current assets less current liabilities. Below we provide a list all balance sheet items and
point out which of them should be regarded as working capital:

equity (position C. in Lithuanian balance sheet) - none of these balance sheet items
constitute working capital;

fixed assets (position A. in Lithuanian balance sheet) – none of these balance sheet
items constitute working capital;

long-term liabilities (position E.I. in Lithuanian balance sheet) - none of these
balance sheet items constitute working capital;

current liabilities (position E.II. in Lithuanian balance sheet)- except of items
specified below, all other balance sheet items constitute working capital:
o
Current portion of long-term debt (position E.II.1. in Lithuanian balance
sheet). This balance sheet item relates to current liabilities representing part
34
of long-term debt (including interests) that is due within one year. Clearly the
whole amount of long-term debt (including its short term part) should be
treated consistently. Since long-term debt is in general incurred to finance
the operations of the company it constitute capital employed. Similarly
current liabilities representing part of long-term debt due within one year
should be treated as capital employed, therefore they are not part of working
capital. Reporting of this part of long-term debts as current liabilities is just
an accounting requirement and is not related to any financial or economic
considerations.
o
Permanent core of overdrafts (position E.II.2. in Lithuanian balance sheet).
Companies enter overdrafts either for financing purposes or for liquidity
purposes. The overdraft due to financing reasons is always permanent and
does not appear and disappear as a consequence of temporary surplus or
deficit on cash. If overdraft occurs due to financing reasons it should be
treated as capital employed and it is not part of working capital. If overdraft
occurs due to liquidity reasons it should be treated as working capital.
o
Current obligations from finance leases (position E.II.1. in Lithuanian
balance sheet). Both, current and non current part of obligations from finance
leases should be treated as a part of long-term financing therefore it is not
part of working capital. The reason for such treatment is that, from the
economical point of view finance leases are simply a form of a loan given by
lessor to a lessee.
o
Liabilities from derivatives that are being used to hedge operators long-term
debt (position E.II.2. in Lithuanian balance sheet). Liabilities aroused from
entering derivative contracts should be treated consistently with the
corresponding losses. If derivatives are used to hedge sources of finance they
should be treated as capital employed therefore they should not be a part of
working capital.
o
Corporate Income Tax (CIT) payable (position E.II.5 in Lithuanian balance
sheet), dividend payable (position E.II.8 in Lithuanian balance sheet).
Liabilities for taxation and dividends are short-term liabilities that arise
because taxation and dividends have not yet been paid. When these liabilities
become payable by an operator, either its cash balances will fall or its debt
will increase (or a combination of the two). Their balances come into being
35
only for the very short period of each year. We suggest that these liabilities
are not treated as working capital.

Current assets - except of items specified below, all other balance sheet items
constitute working capital:
o
Dividends receivable (position B.III in Lithuanian balance sheet). When
these assets become payable by debtor, either its cash balances will rise or
operators debt will decrease (or a combination of the two). Their balances
come into being only for the very short period of year. We suggest that these
receivables are not treated as working capital.
o
Balance sheet assets from derivatives that are being used to hedge operators
long-term debt (position B.III in Lithuanian balance sheet). Assets aroused
from entering derivative contracts should be treated consistently with the
corresponding profits. If derivatives are used to hedge sources of finance
they should be treated as capital employed therefore they should not be a part
of working capital.
Averaged values of the balance sheet positions are used in calculations of working capital
(i.e. opening balance plus closing balance divided by two).
3.2.4 List of principles
1. Ensure that GBVand NBV that are assigned to HCCs match with corresponding
figures in balance sheet statement (obligatory).
2. Ensure that averaged value of balance sheet position are used in calculations of
HD/GBV and NBV/GBV ratios (obligatory).
3. Ensure that working capital in TD-LRAIC model include following positions from
balance sheet statement (obligatory):

current liabilities except of current portion of long term debts, permanent
core of overdrafts entered due to financing reasons, current obligations from
financial leases and liabilities from derivatives that are being used to hedge
operators long-term debt;

current assets except of dividend receivable and assets from derivatives that
are being used to hedge operators long-term debt.
36
4. Ensure that working capital in TD-LRAIC model does not includes the following
positions from the balance sheet statement (obligatory):

fixed assets (position A. in Lithuanian balance sheet);

equity (position C. in Lithuanian balance sheet);

long term liabilities (position E.I. in Lithuanian balance sheet).
5. Ensure that averaged values of the balance sheet positions are used in calculations of
working capital (obligatory).
37
4
CURRENT COST ACCOUNTING
It has to be noted that costs in statutory financial statements is reported on a historic cost and
actual basis while the cost base in TD-LRAIC calculation is set on a current cost and forward
looking basis. Therefore, HCC that are taken from profit and loss acount and balance sheet
are to be revalued appropriately.
CAPEX costs in financial statements are reported on acquisition basis, thus revaluation is
performed in two steps. First, costs are revalued using current cost accounting principles.
Second, allowance reflecting forward looking costs is made. OPEX costs in financial
statements reflect their current values, thus, revaluation is limited to making allowance for
forward looking values.
The current cost accounting theory recognizes three different decisions on use of assets,
which might be considered by operators, and consequently three alternatively methods of
valuation:

Comparative transactions method. Net realizable value (NRV) is the value the asset
would realize if sold (less all discounts and sale costs);

Asset replacement method. Net replacement cost (NRC) is the cost of replacing an
asset by another one of similar characteristics and age;

Discounted cash flows method. Economic value (EV), also called “value in use” is
the net present value of future cash flows arising from the asset.
Based on the above definitions it is possible to estimate current cost of an asset by reference
to its “deprival value”. Deprival value of an asset is defined as the loss, the operator would
suffer if deprived of an asset.
The deprival value must be calculated as the lower from Net Replacement Cost (NRC) and
Recoverable Amount (RA), whereas Recoverable Amount is defined as the higher of Net
Realizable Value (NRV) and Economic Value (EV). This can be illustrated graphically as a
decision tree presented in a figure below:
38
Scheme 9. Calculation of current asset costs
Current cost
MIN
Net Replacement Cost
(NRC)
Recoverable Amount
(RA)
MAX
Net Realisable Value
(NRV)
Economic value
(EV)
In practice the revaluation of an asset is usually limited to calculation of NRC. Therefore we
recommend, that while calculating current cost of fixed assets the calculation of RA can be
ignored unless the NRC is not significantly higher than a corresponding historic value, say
150% of historic value. Additionally EV and NRV methods can be used in order to determine
the current value of operators real estate. Revaluation of fixed assets can be performed by
operator internally or with the help of external experts.
4.1 Asset replacement method
All assets in TD-LRAIC model should be revaluated to the Gross Replacement Cost. For
each HCC the operator has to choose between two methods:

Specific Asset Price Indexation (SAPI);

Detailed Asset Revaluation (DAR).
4.1.1 Application of SAPI
Under SAPI the GBV of a group assets is revaluated to GRC by applying yearly price change
indices that are specific for each group of assets. Theoretically there are many sources to
derive appropriate prices change indices. The indices may be based on an average cost
changes of fixed assets, information from statistical office or from telecommunication
regulatory authority data, but in practice it is difficult to find a comprehensive database to
calculate the indices. Therefore the major challenge in this method is to find appropriate
prices change indices.
SAPI can be applied, if all below listed conditions are fulfilled:

technological standards for the particular group of fixed assets have not changed
significantly;
39

the particular group of fixed assets is internally homogenous, i.e. price trends of all
fixed assets within the group do not differ significantly from each other;

the Gross Book Value has been accurately recorded in the Fixed Asset Register and
is available for the last number of accounting periods that covers the whole useful
life of the particular group of fixed assets;

the accuracy of revaluation depends on method of assets grouping and on index
application. Different assets that have different indexes through years must not be
grouped together.
Applying SAPI allows two alternative treatments of fully depreciated assets. One treatment is
that only assets not fully depreciated are revalued. In this case price change indices are
applied n years backwards, where n equals the useful life of an asset. It means that the GBV
where price change index has been applied may be lower than the total GBV recorded in the
books. The other treatment is that all the assets are revalued and then an appropriate
allowance for fully depreciated assets is applied. In this case price change indices are applied
to all purchase years backwards. The revalued figure is then adjusted like in the DAR
method.
4.1.2 Application of DAR
Under DAR the GBV of a group assets is revalued to GRC by assigning current purchase
price to each single asset of these group one by one. DAR is a common fixed asset
revaluation method used in TD-LRAIC model. As a rule, around 80% of total fixed asset
value is revalued using DAR.
DAR can be applied, if all below listed conditions are fulfilled:

operator must have a reliable database with physical volume of fixed assets;

reliable information about current purchase prices must be available. They can be
gained from public source or from operator data.
Again two alternative approaches to the treatment of fully depreciated assets have to be
discussed. The first one revaluating only the assets that have not been fully depreciated is
rather not applicable in DAR method, since it is very difficult to identify in physical count
the assets that have not been fully depreciated yet – this kind of information is usually not
stored in the database where the physical volumes come from. Therefore in DAR method the
other treatment of fully depreciated assets is applied, namely the one where all the assets are
revalued and then an appropriate allowance for fully depreciated assets is applied.
40
Since most of the assets of telecommunication network operator undergo rapid technological
changes (this relates in first line to telecommunication network) DAR is the common method
applied in the revaluation process. In practice DAR method is a must in revaluation of
telecommunication equipment, while SAPI is applied in most of other group of assets. It has
to be noticed however that everywhere where physical volume can be obtained from reliable
sources DAR should be the preferable method.
Below we list a full list of group of assets together with preferable revaluation method:

ducts and cables – DAR;

switches – DAR;

transmission equipment – DAR;

power plant – DAR;

support and inventory systems – SAPI;

fixtures, fittings and office equipment – SAPI;

PC and IT equipment – SAPI.
4.1.3 List of principles
1. For DAR revaluation ensure that all below listed conditions are fulfilled (obligatory):

there is a database with exact physical volumes of fixed assets;

reliable information about each asset current purchase prices are available. Gain
them from own data or from public source.
2. For SAPI revaluation ensure that all below listed conditions are fulfilled
(recommended):

technological standards for the particular group of fixed assets have not changed
significantly;

the particular group of fixed assets is internally homogenous;

the Gross Book Value has been accurately recorded in the Fixed Asset Register
and is available for the last number of accounting periods that covers the whole
useful life of the particular group of fixed assets;

the accuracy of revaluation depends on method of assets grouping and on index
application.
41
3. If possible the following fixed assets groups revaluate with DAR method
(recommended):

ducts and cables;

switches;

transmission equipment;

power plant.
4. Following assets group may be revaluated with SAPI method (recommended):

support and inventory systems;

fixtures, fittings and office equipment;

PC and IT equipment.
5. Ensure the proper value of price change indices. The indices may be based on an
average cost changes of fixed assets, information from statistical office or from
telecommunication regulatory authority data (obligatory).
4.2 Network revaluation and adjustment
The TD-LRAIC model is based on current cost of an efficient operator. This sentence has a
significant impact on valuation of network related fixed assets. Valuation of a network at
current costs requires application of modern equivalent asset concept, while valuation of a
network of an efficient operator requires application of capacity and optimization
adjustments.
4.2.1 Modern equivalent asset
In the situation, when fixed assets that are still in use are outdated or no longer available on
the market, it may be difficult to assign their current price. In this situation the concept of
Modern Equivalent Asset (MEA) has to be adopted. MEA means an asset that would perform
the same function as the asset to be replaced and is currently available on the market. In an
environment as telecommunication market that is characterized by rapid technological
changes it is critical to state what is the modern equivalent asset. Certainly any analogue
switches should be regarded as outdated technology and should be replaced by some modern
equivalents, but what is the modern equivalent in a switching network. Is it a CCS switch or
ATM/IP switch? Today packet networks – Asynchronous Transfer Mode (ATM) and Internet
Protocol (IP) – are increasingly replacing traditional circuits networks – Common Channel
42
Signalization (CCS). Many operators have installed or are planning to install ATM/IP
switches. These switches increase efficiency of transmission networks and hence lower the
costs. Does it mean that not only analogue switches but also traditional digital switches have
to be regarded as outdated and be replaced by ATM/IP network? These are the strategic
assumptions that have to be agreed before building the TD-LRIC model. In the remaining
part of the section we will address most of the specific MEA cases that may occur at fixedline operator.
4.2.2 Modern equivalent asset in switching network
Although as stated above many operators have installed or are planning to install ATM/IP
switches as a platform to carry voice traffic, we understand that the traditional circuits
network are still prevailing across the world and can be regarded as a standard technology to
convey voice traffic. Therefore we suggest that the MEA in switching network be a
traditional circuit based, digital network. This network consists of few large digital hosts that
concentrate traffic from disperse located remote units or optical network units (ONU),
whereas the ONU are increasingly dislodging the remote units, since they come closer to the
customer premises. The remote units are connected to the hosts by producer’s own interface,
while ONU are connected to the hosts by V 5.1 or V 5.2 interface. The current standard is to
connect ONU by V 5.2 interface. All in all we recommend that all digital hosts and larger
digital remote units (above 1024 subscribers) should be revalued by applying the same digital
technology. Smaller remote units (below 1024 subscribers) should be replaced by ONU.
Larger analogue switches (above 1024 subscribers) should be replaced by digital remote units
of the same produces as the producer of the digital hosts to which the analogue switch is
currently connected. Smaller analogue switches (below 1024 subscribers) should be replaced
by ONU. The ONU should be connect to digital hosts by V 5.2 interface. In some specific
cases MEA could be chosen after the analysis of several alternatives.
4.2.3 Modern equivalent asset in transmission network
We understand the current standard in transmission networks remain still SDH, although
similarly as in switching networks the operators install or are planning to install ATM/IP
networks as a transmission platform. Therefore we suggest that the MEA in transmission
network be a fiber optics SDH network. This network consists of SDH add-drop multiplexers
(ADM) or termination multiplexers (TM) that form nodes and optical cables. Usually ADM
and TM operate at three basic transmission rates – STM-1, STM-4 and STM-16. In addition
in locations of very low traffic demand TM can operate at additional rate – VC-TM. We
43
recommend that all SDH and PDH nodes should be revalued by applying the SDH
technology.
All the long-distance copper cables should be replaced by fiber optics. Long-distance cables
in TD-LRAIC model are defined as all cables that are in local and higher topological levels
of core network:

cables between local switches;

cables between local and transit switches;

cables between transit switches;

cables between transit and international switches;

cables between international switches.
The revaluation process itself follows basically the same path as DAR. The revaluation is
proceeded by the selection of an appropriate device to replace the asset to be revalued. The
revaluation is performed in the following phases:

selecting MEA for each fixed asset to be replaced

performing revaluation of MEA based on DAR method.
Adoption of the MEA concept has an implication in both identifying suitable replacement
costs for old technology assets and ensuring that the asset exhibits the same level of capacity
and functionality. Therefore the costs of the modern equivalent have to be adjusted
proportionally to the extent to which it surpasses the old replaced asset. Such adjustment is
called abatement. There are two types of abatements – qualitative abatements and
quantitative ones. The qualitative abatement arises when MEA exceeds the functionality of
the asset to be revalued. The quantitative abatement arises when MEA exceeds the capacity
of the asset to be revalued.
Since the digital technology is very modular it allows to adjust the capacity of MEA to the
capacity of the asset being replaced accurately. Therefore in practice there are few cases
where the quantities abatements arise. In consequence we recommend the quantities
abatements can usually be ignored.
Quality of MEA usually far excels the quality of the asset being replaced. The qualitative
abatements however are often very judgmental and very difficult to estimate properly and
may influence negatively current cost of revaluated fixed assets. Therefore we similarly
recommend the qualitative abatements be in practice ignored.
44
4.2.4 Impact of modern equivalent assets on other costs
The application of MEA concept has not only impact on the costs of the assets being actually
replaced but on other costs as well:

costs of supporting assets ;

operation and maintenance costs
In order to reflect this impact appropriate MEA adjustments are to be calculated. Digital
technology requires less maintenance and occupies less space. Therefore typically application
of MEA results in lower operation and maintenance costs of switches and transmission and
on lower building costs. The impact of MEA on power plant costs can be argued. The
analogue switches consume much more energy than their digital equivalents. On the other
hand digital switches requires air-conditioning that constitute additional power plant costs.
Both effects are considered to set-off. Therefore we suggest to ignore the calculation of MEA
adjustments on the costs of power plant and power consumption.
4.2.5 Capacity and equipment optimization
Spare capacity correction. This correction may appear in case of oversized network having
spare capacity. Spare capacity is justified if they are results of:

providing the same quality of services;

technical reserves;

equipment modularity;

operational reserves that allows fluent network development.
Spare capacity that is in excess of the justified spare capacity represents unjustifiable costs
and thus should be excluded from the revaluation of the fixed assets.
Inefficiency correction. This correction may appear when the existing processes are
inefficient. The process is inefficient when too much resources are assigned to perform the
process. The inefficiency of the processes may be quantified based on benchmarks and Key
Performance Indicators (KPIs).
Optimization correction. This correction appears when the network topology or structure is
not optimally designed. The network of the operator is the result of historic network
development and further changes. In many cases the network design is not optimal.
45
Let’s assume that the exchange have built up the excess capacity in the trunk group. The
amount of trunks that are not in service is too large and the amount is not justified. Applying
correction that reduces cost by reducing number of trunks will be named as spare capacity
correction.
Additionally let’s assume that the amount of technicians that overlook the exchange is too
large. The definition of processes and responsibilities causes inefficient use of personal
recourses. Organisation can solve the problem by reorganisation and controlling the
performance of individuals e.g. increasing the amount of subscriber lines that have to be
overlooked by one technician. Applying correction that reflects the reduced need for
resources will be named as inefficiency correction.
Local exchange switching low traffic volume is not an optimal solution. Instead one should
consider connecting all subscribers directly to the upper level exchange, like primary
exchange, and eliminating the local exchange. This would optimize the cost by reducing the
redundancy and is named as optimization correction.
4.2.6 List of principles
1. Ensure that in revaluation process all analogue switches are substituted by digital
switches (obligatory).
2. Ensure that in revaluation process all digital hosts and larger digital remotes units
(above 1024 subscribers) are revalued by applying the same digital technology
(obligatory).
3. Ensure that in revaluation process smaller remote units (below 1024 subscribers)
should be replaced by ONU (access system) (recommended).
4. Ensure that in revaluation process larger analogue switches (above 1024 subscribers)
are replaced by digital remote units of the same producer as the producer of the
digital hosts to which the analogue switch is currently connected (obligatory).
5. Ensure that in revaluation process smaller analogue switches (below 1024
subscribers) are replaced by ONU (access system). The ONU should be connected to
digital hosts by V 5.2 interface (recommended).
6. ONU should be connected to digital hosts by V 5.2 interface (obligatory).
7. Ensure that in revaluation process all PDH transmission equipment is substituted by
SDH equipment (obligatory).
46
8. Ensure that in revaluation process all long-distance copper cables are substituted by
fiber optics (obligatory).
9. Apply operational MEA adjustments for correction of operation and maintenance
cost in case of PDH and analogue switches (obligatory).
10. Perform capacity adjustment and allow spare capacity in case of (obligatory):

providing the same quality of services;

technical reserves;

equipment modularity;

operational reserves that allows fluent network development.
11. Perform efficiency analysis for operational activities and apply the efficiency
adjustments where is applicable (obligatory).
12. Perform the optimization analysis for network design and apply the optimization
adjustments. Check whether (obligatory):

the local switch can be substituted by remote unit;

the local switch can be merged with upper level switch.
4.3 Mapping of investments
As it has been discussed figures in the statutory financial statements are reported on a historic
and actual basis while the cost base in LRAIC calculation is set on a current cost and forward
looking basis.
It is fairly easy to calculate the forward looking cost of short-term nature i.e. forward looking
operating cost other than depreciation and forward looking capital cost of working capital.
Calculation of forward looking cost of long-term nature (i.e. forward looking depreciation
cost and forward looking capital cost of fixed assets) requires to estimate the forward looking
values of GRC and NRC. It is the average GRC and NRC values that will be in the year when
interconnection rate will be valid. In order to calculate the forward looking values of GRC
and NRC it is not enough to know the future price of the assets, but their future capacity as
well. The way to estimate future capacity of the assets is to project current capacity by the
increase or decrease in the demand, as presented in the figure below.
47
Scheme 10. Estimation of assets capacity
Forward looking cost
Actual cost
Actual
demand
Forward
looking
demand
Since the estimation of future demand and therefore future capacity of the assets is quite
complex process. That is why LRIC models very often refer to budgeting process that any
way covers this issue, in addition budgeted numbers are blessed by the shareholders (i.e. they
are often accepted by the supervisory board) providing assurance for proper projection.
Therefore calculation of forward looking values of GRC and NRC can be limited to
calculation of actual values of GRC and NRC and then adjusting them by future investment
i.e. budgeted capital expenditures.
It has to be noted that budgeted capital expenditures covers expenditures that are planned to
replace existing assets since the assets will fully depreciate in the near future and
expenditures that are planned to increase current capacity. While mapping investment values
into the LRIC model of course only the investments have to be taken into account that are
planned to increase current capacity.
4.3.1 List of principles
1. Ensure that the future investments have reference to budgeting process providing
assurance for proper projection (recommended).
2. Ensure that the future investments constitute only those expenditures that are planned
to increase current capacity (obligatory).
48
4.4 Calculation of holding gain and backlog depreciation
Basically there are two concepts to calculate the costs of fixed assets – Operating Capital
Maintenance and Financial Capital Maintenance:
Operating Capital Maintenance (OCM) considers the operating capability of an operator.
Capital maintenance under this approach requires the operator to have as much operating
capability (or productive capability) at the end of the period as at the beginning. In OCM
depreciation cost equals Current Depreciation.
Financial Capital Maintenance (FCM) assumes that the financial capital of an operator is
maintained in current price term. This will be the case if shareholder’s funds at the end of the
period are, in real terms, at the same level as at the beginning of the period. In FCM
depreciation cost equals the difference between NRC at the beginning and at the end of the
accounting period. Therefore, in conditions of rising/falling assets prices, capital
maintenance cost is lower/higher than current depreciation.
FCM is considered as the appropriate capital maintenance concept to use. The formula for
the cost of fixed assets under FCM concept is presented below:
C (n)  NRC (n)  WACC  CD(n)  HG (n)
(5)
Whereas:

NRC (n) – average net replacement cost;

WACC – weighted average cost of capital;

CD(n) – current depreciation in period n;

HG(n) – holding gain in period n, please note that the holding gain refers to only one
year interval.
Index n refers to the period for which costs are calculated in TD-LRAIC. Index n-1 refers to
the period when LRAIC calculation is performed. Index n-2 refers to a period from which
data is taken. For example, if model which is done in 2005 and it calculates costs of 2006 on
a basis of data of 2004, n-2 means 2004, n-1 means 2005 and n means 2006.
GRC (n)
NRC (n) 
CD(n)  GRC (n)
NBV (n)
NBV (n  1)
 GRC (n  1)
GBV (n)
GBV (n  1)
2
HD (n)
GBV (n)
(6)
(7)
49
Whereas:

GBV(n) – gross book value at the end of period n;

NBV(n) – net book value at the end of period n;

GRC(n) – gross replacement cost at the end of period n;

HD(n) – historical depreciation in period n.
Holding Gain (HG) represents the gains or loses from changes in asset current value
resulting from asset price changes and not related to asset operating capacity. In conditions
of rising asset prices, current depreciation cost is lowered by asset revaluation. It means that
in order to maintain asset value, revenues should cover only that part of current depreciation
that is not covered by HG. In conditions of falling asset prices, asset value is lowered by
current depreciation as well as by decrease of asset price. So, in order to maintain value of
assets, revenues should cover both depreciation and decrease in asset price.
The formula for HG is not so simply and straight forward as for NRC or CD. In academic
documents there is a number of formulas to calculate the holding gain each of these formulas
is mutually equivalent to each other. Below are presented four alternative formulas to
calculate the holding gain:
 GRC (n) GRC (n  1) 
HG (n)  NBV (n  1)  


 GBV (n) GBV (n  1) 
HG (n) 
NBV (n  1)
 GRC (n)  GRC (n  1)
GBV (n  1)
(8)
(9)
HG (n)  NRC (n)  NRC (n  1)  CD(n)
(10)
HG (n)  GRC (n)  GRC (n  1)  BD (n)
(11)
Whereas:

BD(n) – backlog depreciation in period n.
Backlog depreciation in period n accounts for the difference between GRC at the end of
period n less NRC at the end of period n, accumulated current depreciation at the beginning
of period n and current depreciation for period n, as presented below:
BD (n)  GRC (n)  NRC (n)  CAD(n  1)  CD(n)
Where:

CAD(n-1) – current accumulated depreciation
50
(12)
CAD(n  1)  GRC (n  1)
CD(n)  GRC (n)
AD(n  1)
GBV (n  1)
(13)
HD (n)
GBV (n)
(14)
The concept of backlog depreciation can be best explained in reference to the relations
between GBV, NBV and accumulated depreciation in HCA. In HCA NBV at the end of
period n equals GBV at the end of period n less accumulated depreciation at the end of
period n. Whereas accumulated depreciation is a sum of historic values for depreciation
accounted since initiation of fixed asset, in specific accumulated depreciation at the end of
period n equals accumulated depreciation at the beginning of period n plus depreciation in
period n. As presented in formula:
HD (n)  AD(n  1)  HD (n)
(15)
Since GBV in HCA is constant the relation between GBV, NBV and accumulated
depreciation holds always. In CCA GRC undergo continuous changes, therefore backlog
depreciation is introduced to reflect the change of GRC in past accumulated depreciation.
Four previously presented formulas for holding gain are mutually equivalent. This is true if
GBV is constant. The GBV of one asset is clearly constant over its useful life. This is
however not valid for the whole HCC. The GBV of assets grouped in one HCC is a sum of
GBV of each asset separately. This means that in order to hold the above assumption of
constant GBV none of the assets could be replaced or purchased during the calculation
period. In practice some of the assets may be replaced or some assets may be purchased
during the calculation period. Hence in order to get correct results, calculating period has to
be divided into separated sub-periods. The approach to sub-dividing calculating period into
infinitesimal sub-periods would be very laborious and would require access to very detailed
information.
In practice the formulas for holding gain are applied for the whole calculating period and in
consequence yield in different results.
To avoid any misunderstandings or misinterpretation of the concept of holding gain we
recommend the regulator to announce one formula for holding gain. We suggest the
following formula for holding gain:
HG (n) 
NBV (n  1)
 GRC (n)  GRC (n  1)
GBV (n  1)
51
(16)
Another practical problem while calculating the cost of fixed asset is that GRC, GBV and
NBV are forward looking figures. At the moment of cost calculation none of the figures are
known. Estimation of all figures is very difficult and constraints by a number of subjective
assumptions.
Therefore we recommend that both ratios of NBV to GBV (i.e.
NBV n 
NBV n  1
and
)
GBV n 
GBV n  1
are assumed to be the same and be equal to the average ratio of NBV to GBV at the end and
at the beginning of the last audited accounting period.
NBV (k ) NBV (k  1)

NBV (n) NBV (n  1) GBV (k ) GBV (k  1)


GBV (n) GBV (n  1)
2
(17)
Whereas:
k denotes last audited accounting period
or alternatively use the
NBV k 
NBV k  1
ratio for GRC n and
ratio for GRC n  1 .
GBV k 
GBV k  1
The forward looking value of GRC is much more critical and represents a product of future
assets quantity of future assets prices. Since fixed line operators do not develop their voice
network very rapidly the difference between future and current assets quantities have
insignificant impact on cost calculation, therefore we recommend that the difference between
current and forward looking figures of GRC related to increase in assets quantities can be
obtained directly from operator’s budget.
GRC (n)  GRC (Vn2 , Pn )  I n1  I n
(18)
GRC (n  1)  GRC (Vn2 , Pn1 )  I n1
(19)
Whereas:

GRC (Vn2 , Pn ) - current assets quantity calculated at forward looking prices for
period n.

I n 1 - planned investments for period n-1 that are related to extension of the network
(are not related to replacement of old assets);

I n - planned investments for period n that are related to extension of the network
(are not related to replacement of old assets).
In consequence the formula for average NRC is one of the following:
52
NRC n  
NRC n  
( GRC Vn 2 , Pn  I n 1  I n )
NBV k 
NBV k  1
 (GRC Vn 2 , Pn 1   I n 1 )
GBV k 
GBV k  1 (20)
2
( GRC Vn 2 , Pn  I n 1  I n )  (GRC Vn2 , Pn1   I n 1 ) NBV k 

2
GBV k 
(21)
In consequence the formula for HG is as follows:
HG (n) 
NBV (k  1)
 GRC (n)  GRC (n  1)
GBV (k  1)
In consequence the formula for CD is as follows:
CD(n)  GRC (n)
HD (k )
GBV (k )
4.4.1 List of principles
1. Apply the following formula for current cost related to fixed assets calculation
(obligatory):
C (n)  NRC (n)  WACC  CD(n)  HG (n)
Whereas:

NRC (n) – average net replacement cost for period n;

WACC – weighted average cost of capital;

CD(n) – current depreciation in period n;

HG(n) – holding gain in period n.
2. Apply the following formula for average net replacement cost calculation
(obligatory):
NRC n  
( GRC Vn 2 , Pn  I n 1  I n )
NBV k 
NBV k  1
 (GRC Vn 2 , Pn 1   I n 1 )
GBV k 
GBV k  1
2
Whereas:

GRC (Vn2 , Pn ) - GRC of current assets quantity calculated at forward looking
prices for period n;
53

I n planned investments for period n that are related to extension of the network
(are not related to replacement of old assets).
3. Apply the following formula for holding gain calculation (obligatory):
HG (n) 
NBV (k  1)
 GRC (n)  GRC (n  1)
GBV (k  1)
4. Apply the following formula for current depreciation calculation (obligatory)
CD(n)  GRC (n)
HD (k )
GBV (k )
4.5 Revaluation of operating expenditures
Operating expenditures are incurred in the same year in which they are expensed. Since
expenditures are always at current prices, the costs incurred in the same year in which they
are expensed, are recorded at current prices too. Therefore operating expenditures are always
recorded at current cost. It should be noticed however that usually operating expenditures
recorded in profit and loss account are incurred (and recorded at current prices) in the year
prior to year of cost calculation, while the operating expenditures that should be mapped to
HCCs are incurred in the year after the year of cost calculation. It results in a two year time
span between the operating expenditures recorded in profit and loss account and the
operating expenditures allocated to HCCs.
It means that in order to set current costs the operating expenditures are to be appropriately
revalued. The revaluation is usually done by indexing the operating expenditures mapped
from profit and loss account by appropriate inflation rate. Certainly the inflation rate may be
different for different HCCs. therefore different indexes should be applied to different HCCs.
Since in low inflationary environment, the indexation would have negligible impact on
change of cost base, therefore in practice the same indexes are applied to groups of HCC.
This is usually forecasted consumer product inflation rate for non-pay type HCCs and
forecasted salary increase index for pay type HCCs.
Similarly due to the two year time span between the figures reported in financial statement
and the figures allocated to HCCs, the operating expenditures recorded in profit and loss
account correspond to a different service volume than the operating expenditures that should
be allocated to HCCs.
54
It means that in order to set forward looking values the operating expenditures are to be
appropriately adjusted by the increase of service volume. It has to be noted, that the service
volume in fixed networks is stable, therefore the forward looking adjustment could be
completely neglected.
4.5.1 List of principles
1. Ensure that cost indexation has been applied to operating expenditures (obligatory).
4.6 Revaluation of working capital
Working capital is due to the same year in which they are invested. Therefore working capital
always reflects current value.
It should be noticed however that usually working capital recorded in balance sheet is due to
(and recorded at current prices) prior year of cost calculation, while the working capital that
should be mapped to HCCs is due to year after the year of cost calculation. It results in a two
year time span between the working capital recorded in balance sheet and the working capital
allocated to HCCs.
It means that in order to reflect current value the working capital is to be appropriately
revalued. The revaluation is usually done by indexing the working capital mapped from
balance sheet by appropriate inflation rate. Certainly the inflation rate may be different for
different HCCs therefore different indexes should be applied to different HCC. Since in low
inflationary environment, the indexation would have negligible impact on change of short
term capital, therefore in practice the same indexes are applied to groups of HCC. This is
usually forecasted by consumer product inflation rate for working capital type HCC.
Similarly due to the two year time span between the figures reported in financial statement
and the figures allocated to HCC, the working capital recorded in balance sheet correspond to
a different service volume than the working capital that should be allocated to HCC.
It means that in order to set forward looking values the working capital is to be appropriately
adjusted by the increase of service volume. It has to be noted, that the service volume in fixed
networks is stable, therefore the forward looking adjustment could be completely neglected.
4.6.1 List of principles
1. Ensure that cost indexation has been applied to working capital (obligatory).
55
5
ROUTING MATRIX
Routing matrixes determine the intensity of network element usage providing interconnection
services. Equipment usage intensity serves as a basis for cost allocation to services. In TDLRAIC routing matrixes are formed to calculate the cost of the following services in fixed
line network:

call set-up;

origination;

termination;

transit.
The routing matrixes are used for two purposes:

calculation of total minutes or total call attempts on particular network elements;

calculation of average number of network elements in providing interconnection
services.
5.1 Calculation of total call attempts
In order to calculate set-up fee it is required to calculate unit cost of NE which cost is driven
by busy hour call attempts (BHCA). The unit cost could be calculated applying simplified or
more complex approach.
In simplified approach the NE cost has to be divided by total call attempts in the network in
the year. The resulting value represents average unit cost for call set-up across all services.
In more complex approach the NE cost has to be divided by total call attempts weighted by
service consumption of signaling resources. The signaling resources of the network that is
driven by BHCA can be consumed in different extent by different services. The extent in
which the service consumes the resources of the NE for Signaling can be expressed in the
amount of information that is required to set-up a call.
The calculation of unit cost of NE for Wholesale billing should be performed by applying
simplified approach, that is dividing wholesale billing costs by total call attempts.
56
5.2 Calculation of total minutes
In order to calculate total minutes on particular network elements the operator has to
construct two sets of matrixes. The first set of matrix (set A of routing matrixes) is to
calculate total number of minutes on subscriber units and total number of minutes on
transmission links between remote units and switches. The second set of matrix (set B of
routing matrixes) is to calculate total number of minutes on switches and on transmission
links between switches.
Both A and B sets of matrixes have minute matrixes to represent annual traffic volumes (in
minutes) and traffic structure. Traffic structure operator can base on a monthly (or several
months) basis. Monthly data on traffic structure is annualised using data on annual traffic
volumes (in minutes).
5.2.1 Set A of routing matrixes
Set A of routing matrixes consists of the following matrixes:

minute matrix;

subscriber unit matrix;

intraswitch transmission link matrix.
The size of all matrixes is the same, in these matrixes each row represents separate traffic
source and each column represent separate traffic destination.
The traffic source can be a remote unit, switch, point of interconnection with other national
(e.g. mobile networks) or international telecommunication network. A remote unit is defined
as traffic source if originating subscriber is connected to remote unit. Switch is defined as
traffic source if originating subscriber is connected directly to switch. Point of
interconnection with other national or international telecommunication network is defined as
traffic source if originating subscriber is located in these telecommunication networks.
The traffic destination can be a remote unit, switch, point of interconnection with other
national (e.g. mobile networks) or international telecommunication network. A remote unit is
defined as traffic destination if terminating subscriber is connected to remote unit. Switch is
defined as traffic destination if terminating subscriber is connected directly to switch. Point
of interconnection with other national or international telecommunication network is defined
as traffic destination if terminating subscriber is located in these telecommunication
networks.
57
It has to be noted that some of originating points and some of terminating points can be
aggregated. It is enough to list four separate originating points and four separate terminating
points:

remote units;

switches;

points of interconnections with other national networks;

points of interconnections with other international networks.
The format of all routing matrixes is depicted in the following figure.
Scheme 11. A set of routing matrixes
RU
POI
international
POI international
Switch
RU
POI
national
POI national
Switch
Filling out minute matrix
This matrix provides information about minute volumes. The total traffic originated in one
traffic source has to be reported in Minute Matrix in its corresponding row and be spread
across diverse columns according to the traffic destination. In specific traffic originated in
traffic source A and terminated in traffic source B should be reported on the intersection of
row A and column B.
Filling out subscriber unit matrix
This matrix provides information about number of subscriber units involved in individual
traffic flows. Number of subscriber units involved in telephone connection between traffic
source A and traffic destination B should be reported on the intersection of row A and
column B. It has to be noted that on the intersection of row A and column B where both
originating and terminating point is remote unit or the switch the number of subscriber units
involved in traffic flows equals to 2. In case where one from originating and terminating
points is remote unit or switch and the other is point of interconnection with other network
58
the number of subscriebr units involved in traffic flows equals to 1. In all other cases the
number of susbcriber units equals to zero (transit).
Filling out intraswitch transmission link matrix
This matrix provides information about number of intraswitch transmission links involved in
individual traffic flows. Intraswitch transmission link is defined as a link between remote
concentrators units and local switches. Number of intraswtich transmission links involved in
telephone connection between traffic source A and traffic destination B should be reported
on the intersection of row A and column B. It has to be noted that on the intersection of row
A and column B where both originating and terminating point is remote unit the number of
intraswitch transmission links involved in traffic flows equals to 2. In case where one from
originating and terminating points is remote unit and the other is switch or point of
interconnection with other network the number of intraswitch transmission links involved in
traffic flows equals to 1. In all other cases the number of intraswitch transmission links
equals to zero.
Calculation of total minutes
In order to calculate the total minutes on subscriber units every cell of minute matrix has to
be multiplied by corresponding cell in subscriebr unit matrix. In general cell on intersection
of row n and column m in minute matrix has to be multiplied by cell on intersection of row n
and column m in subscriber unit matrix. The sum of the products of these multiplications
represents total minutes on subscriber units.
In order to calculate the total minutes on intraswtich transmission links the similar
calculations has to be performed as for subscriber units.
5.2.2 Set B of routing matrixes
Set B of routing matrixes consists of the following matrixes:

minute matrix;

local switch matrix;

transit switch matrix;

local transmission link matrix;

long-distance transmission link matrix.
The size of all matrixes is the same, in these matrixes each row represents separate traffic
source and each column represent separate traffic destination.
59
The traffic source can be a switch, point of interconnection with other national (e.g. mobile
networks) or international telecommunication network. A switch is defined as traffic source
if originating subscriber is connected directly or through a remote unit to this switch. Point of
interconnection with other national or international telecommunication network is defined as
traffic source if originating subscriber is located in these telecommunication networks.
The traffic destination can be a switch, internet, point of interconnection with other national
(e.g. mobile networks) or international telecommunication network. A switch is defined as
traffic destination if terminating subscriber is connected directly or through remote unit to
this switch. Point of interconnection with other national or international telecommunication
network is defined as traffic destination if terminating subscriber is located in theses
telecommunication networks.
It has to be noted that every originating point of interconnection with other national
telecommunication network should represent a separate row in the routing matrixes and every
terminating point of interconnection with other national telecommunication network should
represent a separate column in the routing matrixes. On the other hand all originating points
of interconnection with international telecommunication networks can be jointed into one
row in the routing matrixes and all terminating points of interconnection with international
telecommunication networks can be jointed into one column in the routing matrixes.
The format of all routing matrixes is depicted in the following figure.
Scheme 12. B set of routing matrixes
Switch
POI
international
POI international
POI national
Internet
Switch
POI
national
Filling out minute matrix
This matrix provides information about minute volumes. The total traffic originated in one
traffic source has to be reported in Minute Matrix in its corresponding row and be spread
across diverse columns according to the traffic destination. In specific traffic originated in
traffic source A and terminated in traffic source B should be reported on the intersection of
row A and column B.
60
Filling out local switch matrix
This matrix provides information about number of local switches involved in individual
traffic flows. Number of local switches involved in telephone connection between traffic
source A and traffic destination B should be reported on the intersection of row A and
column B. While determining the number of local switches involved in individual traffic
flows only first order routes has to be taken into account. It has to be noted that assuming the
same route is for a traffic flow from a traffic source A to a traffic destination B and from a
traffic source B to a traffic destination A the local switch matrix should be diagonally
symmetric.
Filling out transit switch matrix
This matrix provides information about number of transit switches involved in individual
traffic flows. Number of transit switches involved in telephone connection between traffic
source A and traffic destination B should be reported on the intersection of row A and
column B. While determining the number of transit switches involved in individual traffic
flows only first order routes has to be taken into account. It has to be noted that assuming the
same route is for a traffic flow from a traffic source A to a traffic destination B and from a
traffic source B to a traffic destination A the transit switch matrix should be diagonally
symmetric.
Filling out local transmission link matrix
This matrix provides information about number of local transmission links involved in
individual traffic flows. Local transmission link is defined as a link between two local
switches or between local and transit switch or between local switch and point of
interconnection with other national network. Number of local transmission links involved in
telephone connection between traffic source A and traffic destination B should be reported
on the intersection of row A and column B. While determining the number of local
transmission links involved in individual traffic flows only first order routes has to be taken
into account. It has to be noted that assuming the same route is for a traffic flow from a
traffic source A to a traffic destination B and from a traffic source B to a traffic destination A
the local transmission links matrix should be diagonally symmetric.
Filling out long-distance transmission link matrix
This matrix provides information about number of long-distance transmission links involved
in individual traffic flows. Long-distance transmission link is defined as a link between two
61
transit switches, between transit and international switch or between transit switch and point
of interconnection with other national network. Number of long-distance transmission links
involved in telephone connection between traffic source A and traffic destination B should be
reported on the intersection of row A and column B. While determining the number of longdistance transmission links involved in individual traffic flows only first order routes has to
be taken into account. It has to be noted that assuming the same route is for a traffic flow
from a traffic source A to a traffic destination B and from a traffic source B to a traffic
destination A the long-distance transmission links matrix should be diagonally symmetric.
Calculation of total minutes
In order to calculate the total minutes on local switches every cell of minute matrix has to be
multiplied by corresponding cell in local switch matrix. In general cell on intersection of row
n and column m in minute matrix has to be multiplied by cell on intersection of row n and
column m in local switch matrix. The sum of the products of these multiplications represents
total minutes on local switches.
In order to calculate the total minutes on transit switches, local transmission links and longdistance transmission links the similar calculations has to be performed as for local switches.
5.3 Calculation of average number of network elements
5.3.1 Set A of routing matrixes
In order to calculate average number of intraswtich transmission links involved in providing
interconnection service in the first step total number of minutes of individual interconnection
services (e.g. origination, termination and transit) has to be calculated. Further it will be
referred as total service minutes. In the second step total number of minutes of individual
interconnection services weighted by number of intraswtich transmission links involved in
that service has to be calculated. Further it will be referred as weighted service minutes for
intraswtich transmission links. In the last step a ratio of weighted service minutes for
intraswtich transmission links to total service minutes has to be calculated. The ratio
represents average number of intraswtich transmission links involved in individual
interconnection service.
In order to calculate weighted service minutes for intraswtich transmission links the
intraswtich transmission links matrix has to be modified. For example in order to calculate
weighted termination service minutes for intraswtich transmission links all cells in
intraswtich transmission links matrix related to other services than termination
interconnection has to be set to zero. Further every cell of minute matrix has to be multiplied
62
by corresponding cell in intraswtich transmission links matrix (like it has been done in the
process of calculating total minutes on network elements). The sum of the products of these
multiplications represents weighted termination service minutes for intraswtich transmission
links. Calculation of weighted origination or transit service minutes is calculated similarly.
In order to calculate average number of susbcriber units involved in providing
interconnection service the similar calculations has to be performed as for intraswtich
transmission links. It has to be noted that the result of average number of subscriber units is
easy to predict. For all calls originating and terminating inside the network (on-net calls) the
average number of subscirber units will be equal to 2. For all calls originating or terminating
in other telecommunication network (off-net calls) the average number of subscirber units
will be equal to 1. For all transit calls the average number of subscirber units will be equal to
zero. This is why the calculation of the average amount of subscirber units could be omitted
from the calculation.
5.3.2 Set B of routing matrixes
In order to calculate average number of local switches involved in providing interconnection
service in the first step total number of minutes of individual interconnection services (e.g.
origination, termination and transit) has to be calculated. Further it will be referred as total
service minutes. In the second step total number of minutes of individual interconnection
services weighted by number of local switches involved in that service has to be calculated.
Further it will be referred as weighted service minutes for local switches. In the last step a
ratio of weighted service minutes for local switches to total service minutes has to be
calculated. The ratio represents average number of local switches involved in individual
interconnection service.
In order to calculate weighted service minutes for local switches the local switch matrix has
to be modified. For example in order to calculate weighted termination service minutes for
local switches all cells in local switch matrix related to other services than termination
interconnection has to be set to zero. Further every cell of minute matrix has to be multiplied
by corresponding cell in local switch matrix (like it has been done in the process of
calculating total minutes on network elements). The sum of the products of these
multiplications represents weighted termination service minutes for local switches.
Calculation of weighted origination or transit service minutes is calculated similarly.
In order to calculate average number of transit switches, local transmission links and longdistance transmission links involved in providing interconnection service the similar
calculations has to be performed as for local switches.
63
5.4 List of principles
1. The routing matrixes are used for two purposes (obligatory):

calculation of total minutes or total call attempts on particular network elements;

calculation of average number of network elements in providing interconnection
services.
2. In order to calculate total call attempts on network elements for Signaling the
operator should use call attempts weighted by service consumption of signaling
resources (recommended).
3. In order to calculate total call attempts on network elements for Wholesale billing the
operator should use total call attempts (recommended).
4. In order to calculate total minutes on particular network elements the operator has to
construct two sets of matrixes (set A and set B) (obligatory).
5. Set A of routing matrixes consists of the following matrixes (obligatory):

minute matrix;

intraswitch transmission link matrix.
6. The format of all set A routing matrixes is depicted in the following figure
(obligatory).
RU
POI
international
POI international
Switch
RU
POI
national
POI national
Switch
7. Set B of routing matrixes consists of the following matrixes (obligatory):

minute matrix;

local switch matrix;

transit switch matrix;
64

local transmission link matrix;

long-distance transmission link matrix;
8. The format of all routing matrixes is depicted in the following figure (obligatory).
Switch
POI international
POI
international
POI national
Internet
Switch
POI
national
9. The ratio of weighted service minutes for a particular network element to total
service minutes represents average number of a particular network element involved
in individual interconnection service (obligatory).
65
6
REQUIREMENTS FOR MODEL FUNCTIONALITY
TD-LRAIC modeling consists of several complex and complicated calculation steps. In
practice this often yields in big and hardly understandable for outside experts TD-LRAIC
models with complicated internal links. Transparency of the model should be an objective of
top priority for operator.
The main requirements for model functionality are as follows:

TD-LRAIC model should be created on a basis of standard software. The model
should produce reports that will be agreed upon with the Regulator.

Model should clearly separate each interconnection service LRAIC cost calculation
step, point out final and intermediate results.

TD-LRAIC model should contain ability to perform sensitivity analysis examining
the impact on intermediate and final model results of change in separate factors like
NRC, WACC, revaluation methodologies, length of asset lives and other.
We recommend thorough model documentation, which contains but not limits itself to
detailed descriptions of the structure of the model, data sources, model assumptions,
calculation steps, list of HCCs, list network elements and other.
66
7
APPENDIX NO. 1. CALCULATING COST OF LEASED LINES
7.1 General section
The purpose of this appendix is to provide guidelines to calculate the LRAIC of trunk
segment of leased lines (referred further as leased lines). End to end leased lines consist of
two network segments:

terminating segment - the connections between customer's sites and telecom operator
transmission network;

trunk segment – conveyance part of the transmission network.
Generally the calculation of LRIC of leased lines can be divided into two consecutive phases:

in the first phase, the total incremental cost of all leased lines has to be calculated;

the second phase is concerned on de-averaging the costs by types and distances.
The first phase – focused on calculating the total incremental cost of all leased lines – can be
almost deemed as a by-product in the model for calculating LRIC of voice interconnection
services. At this point it has to be noted that the incremental cost of all leased lines can be
classified in three separate NE:

leased lines transmission;

leased lines dedicated systems;

leased lines wholesale.
The NE for leased lines transmission relates to the incremental costs of the overall
transmission capacity that is consumed by leased lines, in specific it covers the costs of
multiplexers and cables. The NE for leased lines dedicated systems relates to the costs of
specific systems that are used to provide leased line services, in specific it covers leased lines
management systems like MainStreet™. The NE for leased lines wholesale covers all
specific costs especially labor costs that are related to provision of leased line services like:
billing, service set-up, service termination etc.
It has to be noted that calculating LRAIC of NE for leased lines transmission does not require
any additional HCC above those, which should be defined for the purposes of calculating
LRIC of voice interconnection. The transmission platform is common to voice services, data
services and leased lines services, therefore the same transmission costs (e.g. HCCs) are to be
67
taken into account while calculating the LRAIC of transmission capacity consumed by either
voice, data or leased lines services based on 2Mbps circuits.
The second phase – concerned on de-averaging the costs by types and distances – is
independent to calculating LRIC of interconnection services and may be performed in a
separate model. Cost de-averaging by types and distances is performed in three steps. In the
first step the total incremental costs of all leased lines services is allocated into following
types of services:

Narrow-band leased line services – n x 64kbps;

Broad-band leased line services - < 2Mbps;

Broad-band leased line services – 2Mbps;

Broad-band leased line services – 34Mbps;

Broad-band leased line services – 155Mbps;

Other.
In the second step average unit cost of leased line is calculated. Allocating total incremental
costs of all leased lines services requires to separate the costs of transmission systems into:

the I/O part;

the capacity part.
At this point it has to be noted that every transmission multiplexer can be presented as:

I/O module which constitutes an interface between the multiplexer and other
telecommunication systems, in specific the I/O module may be represented by
tributary cards 21x2Mbps, 32x21Mbps, or electric or optic line cards STM-1, STM-4
or STM-16 (in this context the line cards should be viewed as I/O module);

line module which constitutes an interface with transmission medium in specific the
line module may be represented by optic line cards STM-1, STM-4 or STM-16 (in
this context the line cards should be viewed as line module);

cross-connect which constitutes the rest of multiplexer from the perspective of leased
line cost calculation.
Based on the principles described above:

the I/O part can be defined as I/O module of transmission multiplexer;
68

the capacity part can be defined as cross-connect, line module, and transmission
medium (e.g. cables or radio links).
Since the total incremental costs of all leased lines services represent the cost of multiplexers
and cables themselves and other costs like operation and maintenance, supporting activities,
supporting fixed assets, the allocation to I/O part and capacity part should be done as follow.
The total leased lines transmission costs should be separated into two categories:

costs of multiplexers and all other costs that can be attributed to the multiplexers

costs of cables and all other costs that can be attributed to the cables
Next the costs of multiplexers has to be separated into:

the I/O part

the capacity part,
Other costs attributable to multiplexers have to be allocated to I/O part and capacity part in
the same proportion as the cost of the multiplexers. The costs of cables together will all other
attributable costs constitute the cost of capacity part.
After the total incremental cost of transmission has been separated into I/O part and capacity
part, it can be allocated to different types of leased lines. The capacity part should be
allocated to different types of leased lines proportional to the consumption of 2Mbps circuits.
The I/O part should be allocated proportional to the consumption of I/O cards.
Similarly the cost of leased lines dedicated systems and leased lines wholesale should be
allocated to different types of leased lines proportionally to their consumption.
Average unit cost of leased line has to be calculated, in order to do this the total incremental
costs allocated to one type of leased line service have to be divided by number of provided
leased line circuits. This results in an average cost of leased line service in course of length.
It has to be noted that in case of narrow-band the result has to be adjusted by utilization rate.
Whereas the utilization rate is a ratio of sold transmission capacity of narrow-band leased
lines to total transmission capacity assigned to provide narrow-band leased lines.
Next step involves deriving relationship between length of leased line and its cost. For this
purpose it can be assumed that the costs of I/O cards and wholesale are not distance
sensitive Dist _ fixed , while capacity part and leased lines dedicated systems can be viewed
as distance sensitive Dist _ var . To find the link between length and costs the following has
to be done, separately for each type of leased line service:
69

First, distance ranges have to be defined for leased line services.

Second, the number of network segments of each leased line has to be determined.

Third, each leased line has to be assigned to the defined distance ranges and the
average number of network segments for each distance range has to be
calculated

.
Fourth, the average number of network segments for all leased lines has to be
calculated

Segm range
Segm total .
Finally, the cost of providing the leased line for given range is defined by the
following equation:
LLrange  Dist _ var*
Segm range
Segm total
 Dist _ fixed
A one network segment is defined as continues system of optic fiber with transitional adddrop multiplexers. A one network segment can be build of one or more fiber segments. A
fiber segment is defined as the optic fiber between two adjacent multiplexers.
A network segment can be represented as one SDH physical ring, or one PDH/SDH line
system.
Example:
A
B
Network
Segment 1
Network
Segment 2
Network
Segment 3
In this example we utilized 3 network segments in order to provide leased line service
between point A and B.
70
7.2 List of principles
1. The list of NE in the voice interconnection model has to be extended by the
following three elements (obligatory):

NE for leased lines transmission;

NE for leased lines dedicated systems;

NE for leased lines wholesale.
2. Define separate independent HCCs for cost of systems dedicated for leased lines and
leased lines wholesale cost (recommended).
3. Allocate total incremental costs of all leased lines services into following types of
services (recommended):

Narrow-band leased line services – n x 64kbps;

Broad-band leased line services - < 2mbs;

Broad-band leased line services – 2Mbps;

Broad-band leased line services – 34Mbps;

Broad-band leased line services – 155Mbps;

Other.
4. Separate the costs of transmission systems into I/O part and capacity part
(recommended).
5. Allocate the capacity part to different types of leased lines proportionally to the
consumption of 2Mbps circuits (obligatory).
6. Allocate the I/O part to different types of leased lines proportionally to the
consumption of I/O cards (obligatory).
7. Allocate the dedicated systems and leased lines wholesale cost to different types of
leased lines proportionally to their consumption (obligatory).
8. Perform de-averaging of the unit cost by deriving relation between number of
network segments and length of the leased line (recommended).
71
8
APPENDIX NO. 2. CALCULATING COST OF POINT OF
INTERCONNECTION
The purpose of this appendix is to provide methodology for calculating cost of point of
interconnection using simplified LRAIC approach. The supporting interconnection link
services comprise:

providing capacity in interconnection point;

rendering local network level interconnection point;

rendering national network level interconnection point;
The cost calculation of services can be performed in two phases.
8.1 Phase one
In the first phase costs of service components should be determined. The service components
are either specific fixed asset required to provide the services or man-hours. The example of
fixed assets required to provide the services are listed below:

air conditioning (cooling aggregators 2.5kW, 5.0kW, 10.0kW and 20.0kW cooling
power);

rectifiers (DC 40A, 80A, 160A and 320A);

batteries (loading capacities 160Ah, 320Ah, 640Ah and 1,280Ah);

multiplexer cross connect;

multiplexer line module;

multiplexer I/O part;

additional transmission equipment;

ducted optical cable (costs per 1 km).
The costs of the fixed assets should be calculated in the following way. In the first step GRC
should be assigned to each of the fixed assets. The GRC for power plant and transmission
devices should be derived directly from price list obtained from suppliers operating on local
market or based on the existing frame contracts. Additional transmission equipment should
be calculated by applying mark-up on GRC of transmission devices based on values in the
72
main TD-LRAIC model (for example derived by dividing additional transmission equipment
cost like DDF or ODF by transmission devices cost).
In the second stage annual costs of the specific fixed assets should be calculated. The
calculation of annual costs followed the same rules as presented in section 4.4.
In the third stage mark-up for cost of building, other fixed assets, operation and maintenance
and supporting activities should be calculated. It has to be noticed that if the benchmarks
applied to calculate mark-up represents some averaged figures (for example derived by
dividing total building costs by total telecommunication asset costs), hence the same
benchmarks has to be applied to all telecommunication assets.
The cost of man-hours should be calculated in three stages. In first stage the total operational
cost related to payroll should be mapped from the profit and loss accounts. The cost related
to payroll should include salary and salary related costs like social security and other taxes.
In the second stage an average payroll of employee in telecommunication sector in a year
should be calculated by dividing the total operational cost related to payroll by number of
average number of employees in corresponding year. In the last stage an average man-hour
cost should be calculated by dividing average payroll of employee in a year by average
number of working hours in a year. In the last stage mark-up for building, other fixed assets
and supporting activities should be calculated.
In case estimated costs significantly differs from the costs incurred by efficient operator,
which can be estimated by using appropriate benchmarks, according to LRAIC methodology
efficiency corrections have to be made.
8.2 Phase two
In the second phase the costs of services should be calculated. The calculation should be
performed by applying relevant number of service components per each service. The
calculations should assume some utilization of the service components presented in phase
one. In fact the utilization of these components relates very much on the organization of an
operator, the specificity of interfaces with other operators, quality of service and other
factors. Therefore the specific list of activities and utilization factors for each service should
be prepared by the operators individually.
73
8.3 Numerical Example
Let’s analyze the calculation of cost of service based on below examples for one-time and
annual fee service.
8.3.1 Providing capacity for IC link (one-time fee)
IC link installation requires: receiving and proceeding of order, installation of transmission
equipment, cross-connection of cables on DDF and ODF, setting billing and the link on a
switch.
Following assumptions could be done to calculate the utilization rate of man-hours:
Activity
Man-hours
Explanation
Receiving
and
proceeding
order
A hr
It is assumed that receiving and proceeding of IC link order is
not day-to-day and not automated procedure, it requires to coordinate a wide range of activities – ordering installation of
additional
transmission
equipment,
ordering crossconnections, ordering set-up on switch, ordering changes in
billing system.
Installation
of
transmission
equipment
B hr
It has to be noted that cost of installation is included in GRC
of transmission devices and cost of supervising and receipt of
installation work is included in mark-up for operation and
maintenance. Therefore in the cost of IC link installation only
additional administrative resources related to contact the
supplier and ordering transmission devices are to be
considered if any.
Crossconnection
of cables
C hr
Cross-connection of cables is a routine operation. It requires to
cross-connect cables on DDF and ODF. An additional mark-up
for administration and mobilization of resources can be
included.
Setting link
on switch,
setting
billing and
link tests
D hr
Setting link on a switch. Setting billing. Tests of ITAD
records.
Total
F hr
8.3.2 Providing capacity for IC link (monthly costs)
IC link operation requires number of transmission equipment. The cost of this service should
represent incurred capital cost together with operation and maintenance cost. It has to be
noted that cost of installation is included in GRC of transmission devices and cost of
74
supervising and receipt of installation work is included in mark-up for operation and
maintenance.
While calculating the cost of IC link the following equipment is required:

multiplexer cross connect;

multiplexer line module;

multiplexer I/O part;

A unit base (STM-1);

B optical interface (STM-1);

C tributary card (32 x 2Mbps);

D km of ducted cable.
The utilization rates for unit base and tributary cards should corresponds to an average
number of 2Mbps circuits on an IC link with alternative operators. The figures should
represent totals of transmission components at incumbent and new entrant side. For example
assuming that an IC link comprises in average 16 2Mbps circuits and 1 km of cable and
assuming that there is no possibility for sharing infrastructure with other operators the
following utilization rates could be set:

two STM-1 units;

two STM-1 optical interfaces assuming transmission nodes operate in TM mode;

two 32x2 Mbps tributary cards;

one km of ducted cable (assuming a distance of 1km between two sides).
In order to derive unit cost of service (per 2Mbps) the above utilization rates should be
divided by assumed average number of 2 Mbps circuits per IC link (in this example by 16).
75
9
APPENDIX NO. 3. CALCULATING COST OF CARRIER
SELECTION, CARRIER PRESELECTION AND NUMBER
PORTABILITY
The purpose of this appendix is to provide guidelines for calculating cost of supporting
services using simplified LRAIC approach. Services that are covered in this appendix
comprise:

Carrier preselection (CPS);

Carrier selection (CS);

Number portability (NP).
Costs involved in providing NP, CS and CPS are most usefully be categorized as either “setup costs”, being the costs incurred in making the services available, or “consumption costs”
which are the additional costs incurred when customers make use of the services.
The cost calculation of services can be performed in two phases.
9.1 Phase one
In the first phase costs of service components should be determined. The service components
are either specific fixed asset required to provide the services or man-hours.
The example of fixed assets involved in providing CS, CPS and NP services is IN platform –
software, hardware and related equipment. The costs of the fixed assets should be calculated
in the following way. In the first step GRC should be assigned to each of the fixed assets. In
the second stage annual costs of the specific fixed assets should be calculated. The
calculation of annual costs followed the same rules as presented in section 4.4.
In the third stage mark-up for cost of building, other fixed assets, operation and maintenance
and supporting activities should be calculated. It has to be noticed that if the benchmarks
applied to calculate mark-up represents some averaged figures (for example derived by
dividing total building costs by total telecommunication asset costs), hence the same
benchmarks has to be applied to all telecommunication assets.
The cost of man-hours should be calculated in three stages. In first stage the total operational
cost related to payroll should be mapped from the profit and loss accounts. The cost related
to payroll should include salary and salary related costs like social security and other taxes.
76
In the second stage an average payroll of employee in telecommunication sector in a year
should be calculated by dividing the total operational cost related to payroll by number of
average number of employees in corresponding year. In the last stage an average man-hour
cost should be calculated by dividing average payroll of employee in a year by average
number of working hours in a year. In the last stage mark-up for building, other fixed assets
and supporting activities should be calculated.
In case estimated costs significantly differs from the costs incurred by efficient operator,
which can be estimated by using appropriate benchmarks, according to LRAIC methodology
efficiency corrections have to be made.
9.2 Phase two
In the second phase the costs of services should be calculated. The calculation should be
performed by applying relevant number of service components per each service. The
calculations should assume some utilization of the service components presented in phase
one. In fact the utilization of these components relates very much on the organization of an
operator, the specificity of interfaces with other operators, quality of service and other
factors. Therefore the specific list of activities and utilization factors for each service should
be prepared by the operators individually.
9.3 Numerical Example
9.3.1 Set-up costs
CPS and CS services
This section describes basic principles of estimating CS and CPS set-up costs. Pre-selection
setting requires:

receiving and proceeding of order;

checking authorization;

setting changes on switch and billing system.
77
Following could be done to calculate the duration of activities:
Activity
Duration
Explanation
Receiving and
proceeding
order
A min
Additional costs related to receiving and processing
order.
Checking
authorization
B min
Additional costs related to checking authorization. For
the purpose of calculation the detail description of the
process should be provided.
Setting changes
on switch and in
billing system.
C min
Additional costs related to setting changes on switch and
in billing system.
Total
D min
Setting subscriber changes on switch and in billing systems are routine and simple
operations. If these operations are done case by case they can take a few minutes each. If,
however, the operations are done in batches (in hundreds of subscribers) then the time
calculated per subscriber is negligible. Batch based change settings require automation of
procedures, which in turn requires appropriate interface with new entrants.
Number portability per subscriber set up cost
Setting up number portability for subscriber requires:

receiving and proceeding of order;

checking possibility to provide service;

setting changes in CRM database;

setting changes on switch and billing system.
Following assumptions could be done to calculate the utilization rate of man-hours:
Activity
Duration
Explanation
Receiving and
proceeding
order
A min
Additional costs related to receiving and processing
order.
Checking
possibility to
provide service
B min
Additional costs related to checking possibility to
provide service. The information required to check the
possibility of number portability can be derived from
basic databases used for other day-to-day operations,
therefore no additional allowance for maintenance of
dedicated databases is required.
78
Activity
Duration
Explanation
Changing
subscriber data
in CRM
database
C min
Additional costs related to changing subscriber data in
CRM database.
Setting changes
on switch and in
billing system.
D min
Additional costs related to setting changes on switch and
in billing system.
Total
E min
9.3.2 Consumption costs
In order to estimate consumption costs of CS, CPS and NP the new NE should be created.
The NE related to CS, CPS and NP should comprise the cost of specific systems used for
providing the service, in specific, systems used for assesing routing information for the
selected carrier. This query can be achieved using Intelligent Network (IN) techniques as it is
a case in Lithuania. In LRAIC model at least three additional NEs should be created:

NE related to CS;

NE related to CPS;

NE related to NP.
CPS and CS services
The additional charge for CS and CPS should be based on network charges (per minute) and
incorporated into the interconnection regime. In Lithuania, additional per minute costs are
caused by utilization of Intelligent Network system. In order to calculate these costs
Intelligent Network costs mapped to NE for preselection should be divided by number of pre
selected traffic.
It is important to note that IN platform is used to provide other services (i.e. 900 number 800
number services). Thus, CS and CPS services should bear only part of IN costs that is
attributable to the particular services.
Number portability
It has to be noted that number portability service can be implemented in two ways: as on –
switch or off switch solution. This paper refers to on switch solution as it was established in
Lithuania.
79
The choice of technical solution have cost implications which affects the cost burden of
different operators and the balance between the establishment and consumption costs that
operator will face. On-switch solutions rely on information in the donor switch (i.e. the
switch where the subscriber was initially located). Therefore, the calls for ported number are
firstly routed to donor switch and after that routed forward to recipient network (call
forwarding). Therefore there is additional conveyance costs for traffic to ported numbers that
are caused by longer transmission route for ported calls.
In order to reflect the longer transmission and switching route for ported calls the separate
routing matrix for traffic to ported numbers has to be created. The principles of creating
routing matrix are explained in section 5.
80
No.
Abbreviation
Term
Description
Access network
Portion of a public telecommunications network that connects access nodes of core network to individual
subscribers.
Accumulated
depreciation
Depreciation accumulated from the period the asset was acquired.
3.
Backlog
depreciation
The difference between accumulated depreciation in historic cost accounting and accumulated depreciation in
current cost accounting.
4.
Broadband
Bandwidth in a communication channel not lower than 144 kbps.
1.
2.
AD
5.
BHCA
Busy hour call
attempts
Number of call attempts in a busy hour.
6.
BHT
Busy hour traffic
Amount of traffic in a busy hour.
Call
Connection established by means of a publicly available telephone service allowing two-way communication
in real time.
7.
8.
CAPEX
CAPEX
Capital expenditure costs. CAPEX costs comprise depreciation and ROI.
9.
CE
Capital employed
Capital employed to finance activities of a company. Capital employed comprise equity and long term
liabilities.
10. CPS
Carrier preselection
Carrier selection pre-selection service, which enable the subscriber to use the service of alternative operator in
the field of fixed line telephony without dialing a special code.
11. CS
Carrier selection
Individual carrier selection service, which enable the subscriber to use the service of alternative operator in the
field of fixed line telephony by dialing a special code.
12.
Common and
joint costs
Cost that need to be allocated to several service.
13.
Core network
Group of network components switching and transmitting voice traffic. Core network comprise switches, local
and remote subscriber units as well as transmission equipment between network nodes.
81
No.
Abbreviation
Term
Description
14.
Cost driver
A factor that influences the existence and amount of costs.
15. CVR
Cost volume
relationship
Relationship between total value of cost and cost driver.
16.
Costs
Decrease in economic value for a company due to usage of fixed assets, sale of assets, loss of assets, decrease
in asset value or increase in liabilities over a period, which results in decrease in equity capital.
17. CAD
Current
accumulated
depreciation
Depreciation accumulated from the period the asset was acquired expressed in current cost accounting terms.
18. CA
Current assets
Asset that is consumed by a company to gain economic benefit during one year or one accounting period.
19. CCA
Current cost
accounting
Accounting of costs in terms of current costs and prices of products and services.
20. CD
Current
depreciation
Depreciation cost expressed in current cost accounting terms.
21. CL
Current liabilities
Liabilities which have duration shorter than one year or one accounting period.
22. D
Debt / Long term
liabilities
Liabilities with a maturity longer than a year.
23. DAR
Detailed asset
revaluation
Revaluation method which involved detailed revaluation of each asset component using current values.
24. DDF
Digital
distribution
frame
A device that switches incoming and outgoing signals.
25.
Direct costs
Costs that can be directly attributable to separate products or services.
26.
Duct
60 mm or larger duct for laying cables built between two manholes or between a manhole and other
equipment.
27. EV
Economic value
Value of an asset estimated using discounted cash flow principle.
82
No.
Abbreviation
Term
Description
28.
Exogenous driver
Variable that is not influenced by inner model variables.
29. FCM
Financial capital
maintenance
Cost incurred to maintain current level of financial capital.
30. FA
Fixed assets
Material assets that gives economic benefit to the company having a lifetime of more than a year and the
minimal acquisition cost of the asset is not lower than the minimal value of material asset set by the company.
31. FC
Fixed costs
Costs that are fixed and not influenced by change in volume of service.
32.
Fixed line
telecommunicati
ons network
Public telecommunications network having fixed end points.
33.
Forward looking
cost accounting
Accounting of costs in terms of forward looking costs and prices of products and services.
34. GBV
Gross book value
Acquisition cost of an asset.
35. GRC
Gross
replacement cost
Cost incurred for replacing object of similar type and characteristics not taking into account accumulated
depreciation.
36.
Historic cost
accounting
Accounting of costs in terms of historic (actual) costs and priced of products and services.
37. HD
Historic
depreciation
Depreciation cost expressed in historic cost accounting terms.
38. HG
Holding gain
Income that results due to increase in asset value.
39. HCC
Homogenous
cost category
A set of costs, which have the same driver, the same cost volume relationship pattern and the same rate of
technology change.
40.
Incremental cost
Increase in costs due to increase in volume of service.
83
No.
Abbreviation
Term
Description
41.
Indirect costs
Costs that are indirectly related to a specific product and service and that need to be allocated to different
using economically justifiable drivers.
42. I/O
Input output
Input output part of a device
43.
Leased line
A dedicated telephone line connecting two end-points.
44. LLTS
Leased lines
trunk segment
Part of the leased line in Operator’s core network.
45.
Local subscriber
unit
Subscriber unit that is physically located in the same place as a switch.
46. LRAIC
Long run average
incremental
costing
The principle of long run average incremental costing – estimating change in costs as a result of change in cost
driver volume and dividing them over a unit of service. The costs are measured in the long run, which means
that the company based on the level of demand can change the amount of resources involved in providing a
service i.e. all costs become variable.
47. MEA
Modern
equivalent asset
Asset of the same functionality as the old asset but based on new most popular technology which would be
used by new market player.
48.
Multiplexer
A device that enables more than one signal to be sent simultaneously over one physical channel.
49.
Narrowband
Bandwidth in a communication channel lower than 144 kbps.
50. NBV
Net book value
Remaining value of an asset calculated as a difference between gross book value and accumulated
depreciation plus changes in asset revaluation over time.
51. NRV
Net realizable
value
Price of an asset less potential selling costs.
52. NRC
Net replacement
cost
Cost incurred for replacing object of similar type and characteristics taking into account accumulated
depreciation.
53. NE
Network element
Any network object which physically or logically can be identified as an independent network unit.
84
No.
Term
Description
54.
Network
interconnection
Physical and logical linking of public communications networks used by the same or a different undertaking in
order to allow the users of one undertaking to communicate with users of the same or another undertaking, or
to access services provided by another undertaking. Interconnection is a specific type of access.
55. NP
Number
portability
Service enabling the customer to maintain the same number while changing fixed line telephone service
provider.
56. OCM
Operating capital
maintenance
Cost incurred to maintain operational capacity not lower than in the beginning of the year.
57.
Operator
An undertaking providing or authorised to provide a public communications network or an associated facility.
58. OPEX
OPEX
Operating expenditures that comprise salaries, material and other external service costs.
59. ODF
Optical
distribution
frame
Device that is used to physically group several cables to one cable.
60. ONU
Optical network
unit
Alternative network components for subscriber switches. Examples include: Anymedia, Fastlink, Lucent.
61.
Origination
Transmission of a call from a network point where the call was originated to the switch (including switch)
where interconnection can be established located closest to the subscriber originating the call.
Point of
Interconnection
A location where different telecommunication networks are physically connected to allow the users of one
undertaking to communicate with users of the same or another undertaking, or to access services provided by
another undertaking. Interconnection is a specific type of access.
63.
Provision
Liability the amount and timing of which cannot be precisely measured but can be reliably estimated.
64.
Public phone
Telephone available to the general public, for the use of which the means of payment may include coins
and/or payment instruments.
65.
Recoverable
amount
Maximum amount of money that can be obtained by selling an asset of using in day to day activities.
62.
Abbreviation
POI
85
No.
Abbreviation
Term
Description
66.
Remote
concentrator unit
Subscriber unit remotely located to a switch and connected to a switch via 2 mbps link.
67.
Required rate of
return
Rate of return covering ROI.
68.
Retail activity
Activities necessary to transform wholesale services to retail services encompassing such activities as
customer care, billing, payment collection, marketing and other.
69.
Retail service
Service (product) provided for the final users of telecommunication service.
70. ROI
Return on
investment
Required return on investment calculated by multiplying WACC and capital employed.
71.
Routing matrix
Matrix which represents the intensity of NE usage for different services.
72.
Service
Telecommunication service means service which consists wholly or mainly in the conveyance of signals on
electronic communications networks.
73. E
Shareholders
funds
Part of company’s assets calculated as a difference between total assets and liabilities.
74. SAPI
Specific asset
price indexation
Method of revaluation asset with the help of change in price indexes.
75.
Subscriber
Person who or which is party to a contract with the provider of publicly available electronic communication
services for the supply of such services.
76.
Subscriber unit
Functional network component from one side connected to access network (via line card) and from the other
side to switch (via 2 mbps port).
77.
Supporting
activity
Supporting activity comprise administration, accounting, planning, human resource management and other
supplementary activities.
78.
Switch
(switching host)
Network element that switches calls between two network nodes.
86
No.
Abbreviation
Term
Description
79.
Switching
network
Network of switches that ensures connection among separate fixed line telephony network nodes.
80.
Telecommunicati
ons network
Telecommunication network used to provide public telephone service including transmission of voice between
network end points and other services such as fax or data transmission.
81.
Termination
Transmission of a call from a switch (including switch) where interconnection can be established located
closest to the subscriber receiving the call to the final network point where the call ends.
82.
Transit
Transmission of a call from a switch where interconnection can be established located closest to a subscriber
initiating a call (excluding the switch ) to a switch where interconnection can be established located closest to
a subscriber receiving a call (excluding the switch) via one or more switches.
83.
Transmission
link
A link which ensures transmission of optical and electric signal between two remote geographic units.
84.
Transmission
network
Telecommunication equipment which ensures transmission of optical and electric signals among separate core
network components.
85.
Tributary card
Component of a multiplexer constituting interface between multiplexer and other telecommunication
equipment.
86. VC
Variable costs
Costs that are directly related to change in volume of services.
87. WACC
Weighted
average cost of
capital
Cost of capital calculated as a weighted cost of borrowed and equity capital.
88.
Wholesale billing
system
Information system which involves estimating and invoicing for wholesale services.
89.
Wholesale
service
Service provided to other telecom operators who use the service as raw material for providing retail services.
90. WC
Working capital
Difference between current assets and current liabilities.
87