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CO5123:03 Advanced Issues in Accounting – Written Assignment

Report topic: Accounting for Leases – the impact of AASB (IFRS) 16


You are required to prepare a report to demonstrate your understanding of accounting for leases in relation to two of Australia’s well known mining companies, Rio Tinto Limited (ASX: RIO) and BHP Group (ASX: BHP). With reference to the most recent annual reports from both companies write a report which examines accounting for leases and the major changes that occurred with the application of the new leasing standard.
Your report must include:

  • Evidence of your understanding of lease arrangements and the impact on financial reports, including a demonstration of operating versus financial leases.
  • Summarize the companies, including the value of leases as currently listed in the financial reports.
  • Research on the impact that the accounting rules for leases have had on these two entities.
  • A summary of the short and long-term impacts of the changes to reporting for leases (e.g. financial statements and gearing ratios).
  • You should also be able to demonstrate your understanding of lease arrangements for the wider industry relevant to these companies and the lifecycle and stage of their leases.
    Note that in addressing the above points it may be helpful to consider the following questions:
    (a) Why the Chairperson of the IASB believes that the former accounting standard for leases did ’not reflect economic reality’?
    (b) Why under the former accounting standard were reporting entities’ ‘off balance sheet lease liabilities up to 66 times greater than the debt reported on the balance sheet’?
    (c) Why does the chairperson argue that under the former accounting standard there was ’no level playing field’ between some companies?
    (d) Why the new accounting standards for leases may ‘not be popular with everyone’.

Answer:

Report

AASB-16 Lease

Abstract

The below presented report focuses on giving the understanding about the organization Rio Tinto and BHP Limited and also giving the study about how the changes in the lease and the AASB 16. The organization composition and the lease study are been carried out in the perspective of the new applied AASB that is helpful in showing the business scenario and showing that how the lease formation of companies. The report is showing the position of the lease formation of the companies with the change in the compliances with the adoption of the new AASB 16.

Introduction

It is very important for an organization engaged in business activities to comply with the provisions of leasing as it is an essential activity. However, it is expected that the implementation of the new standards related to lease that is AASB 16 by the Australian government will impact in a great way on the income statements or financial records of the business organizations or entities. It can be stated that AASB 16 provisions are going to impact the overall lease transactions on a comprehensive basis. The current report also focuses on the same topic that is the effect of the implementation of AASB 16 norms and standards upon the financial records particularly in regard to two companies that is Rio Tinto and BHP Billiton. Under the current report, the financial reports of both the companies have been analyzed, and based on such examination the impact of accounting for leases and the major changes that the companies have gone through the implementation of new leasing standards have been determined.

Rio Tinto Limited and BHP Billiton

The Australian company Rio Tinto Limited is listed under the Australian Securities Exchange under the top 30 companies in the list. The Rio Tinto Limited is a leading mining company engaged in exploration working related to minerals and metals, their processing and production, and further engaged in development and marketing. The financial position of the company has increased over the years with a significant operation of increase in the company’s revenue generation by reaching to the planned financial targets of the company (Brown, 2006). The company has performed much impressively in the past few years by gaining significant popularity in the shares (Joubert, et. al., 2017). In the last fiscal year, the company was able to achieve an increase in its revenue generation by more than 3 % to $44.61 billion. The company’s net income has also increased from 22% to $9.77 billion.

BHP Billiton is a multinational organization engaged in the work of mining, extraction of petroleum chemicals and metals all over the globe. The company was founded in Australia in the year 2001. The company is considered one of the biggest mining companies across the globe. The company is recognized as the world’s largest commodities producer, which includes copper, iron ore, uranium, and metallurgical coal, and expanding its business towards the conventional and non-conventional sources of energy including energy coal, oil, and gas (Joubert, et. al., 2017). For BHP Billiton Limited is was observed that the company in the past quarters has achieved an increase in revenue of more than 15% to $25.64 billion and the net income of the company has decreased up to 20% from the financial year.

Lease arrangements and their impact

The lease can be understood as an agreement between the lessor that is the person who owns the asset and the lessee that is the person who uses the asset, where the lessor allows the lessee to use the assets in exchange for some amount of fees to be paid on regular interval and is considered as rent for lease or minimum lease payment. A lease is considered a financial asset because the right to use any property, premises, or equipment is considered an asset (BHP Limited, 2021). The leases have been divided into two categories by the accounting standards. For example, if a company lease any property or equipment for a short period of time, then such lease will be considered as an operating lease however if the lease is for a long period of time, or is categories under lease to own, then such lease will be considered as capital or finance lease (Annual Report, 2020). Though both kinds of lease impact the financial statements and income generation of the company in one are slightly different from the other.  However, the new IFRS 16 standards are going to abolish such differentiation and because of which the companies are required to include in their income statements the debts that they have received from the lease. Payment of Lease amounts are considered as expenses by the accounting standards and are reported under the category of expenses in the entity’s financial statements. Lease as considered as expenses is also categorized under depreciation (Annual Report, 2020).

One of the important benefits of leasing is that it reduces the burden upon the company for onetime payment in cash rather it allows the companies to make short payments for the lease agreement over several years. And because of this, the companies can maintain their essential flow of cash in the regulation of business activity (BHP Limited, 2021). Leasing payments are also tax-deductible from interest as they are categorized under operating expenses. As the company can save its capital by not purchasing the equipment by one-time cash payment, the company can utilize such capital in other needy things or can invest them in better assets (Rio Tinto, 2021).

Provisions related to leasing in AASB 16

The standard provisions stated under the AASB (IFRS) 16 are expected to bring some changes under the income statements, balance sheets, or statements of cash flow for the entities that do not categorize leases in their balance sheets. It was assumed that these provisions are going to greatly impact the companies engaged in the field of energy or petroleum. However, with the addition of debts that the company owns because of the operating lease will not provide any impact upon the lessor, but it definitely going to impact the financial statements of the lessee (BHP Limited, 2021). All the companies that were using the lease arrangements will be affected considerably by the enforcement of IFRS 16 standards and provisions. Both the kinds of leases whether financial or operating are required to be demonstrated in the category of assets and well liability under the financial records of a company (Annual Report, 2020). Both kinds of leases are to be recorded under a single category in the financial statements. And because of this the company’s financial metrics will get affected and impacted in an improved way as more fair representation can be provided which will help the investors (Rio Tinto, 2021).

In relation to the objective behind the implementation of new standards of leasing arrangements, IASB Chairman, Mr. Hans Hoogervorst has stated that “These new accounting requirements bring lease accounting into the 21st century, ending the guesswork involved when calculating a company’s often-substantial lease obligation. The new standard will provide much-needed transparency on companies’ lease assets and liabilities, meaning that off-balance sheet lease financing is no longer lurking in the shadows. It will also improve comparability between companies that lease and those that borrow to buy (Annual Report, 2020).” Hence it can be concluded that the implementation of AASB provisions is a simple step of IASB towards their vision of accountability, transparency, and efficiency (BHP Limited, 2021). It is helpful for both companies to comply with AASB provisions. But on the other hand including lease debts in the balance sheets of the company will result in the disadvantage that both the companies need to increase their liabilities and expenses because of such addition. It was also stated by the Securities and Exchange Commission in a report that the provisions stated under the AASB 16 will not be pleased by everyone in the country and it is evident that the companies are comfortable with the earlier provisions of the leasing arrangements thus with the issuance of a new set of accounting guidance there is a possibility of strong resistance from the side of companies for the change in the leasing standards (Annual Report, 2020).

Impact of AASB 16 upon both companies

The new lease standards as stated under AASB (IFRS) 16 will surely be going to impact the income statements of both the companies that are Rio Tinto Limited and BHP Billiton. It is to be noted that the operating lease has to be added in the financial statements as a leased asset in the assets category and to the contrary as leased liability under the category of liability, thus as a result an interest will be charged upon the items leased. Thus it implies that both will increase that is leased assets as well as liability accordingly (Rio Tinto, 2021). The amount of some financial data will increase for example the capital expenditure in return for operating activities, net assets, current ratio, depreciation, and operating profit. Whereas on the other hand, some financial data will decrease such as capital from financing activities, total equity, and asset turnover ratio. But there exist some financials that do not get impacted with such lease provisions that are capital employed and its return, profit before cash, to aggregate cash flow (Annual Report, 2020).

As both the companies are engaged in drilling and mining activities they required highly powerful machines and equipment for the purpose of regulating their business activities so it is required for both the companies to restructure their funding especially in terms of short time lease of finance and long time lease of operation. It is also required for the companies to review their non-capitalized as well as capitalized assets at the timing of signing any kind of lease agreement (BHP Limited, 2021).

There is a certain number of benefits that can be received from the AASB 16 provisions for example both the companies will be able to produce more reliable and accurate financial statements, can use their transactions related to leasing in a much better way, which will result in the accounting system to be more precise (Rio Tinto, 2021). With proper inclusion of lease transactions both the companies can conduct more accurate audits of income statements either external with the independent auditor or internal and as a result, they both will be able to determine that whether or not the companies are working according to the estimated budget or not. It is advised for the companies to utilize each benefit that is available to them with the standards of AASB 16 and has to work with full dedication to favor their shareholders or investors (Xu, et. al., 2017).

With the implementation of AASB 16 rules and regulations, the reporting of data in terms of finance is going to enhance in a better way and will provide an increased competitive advantage to both the companies in front of other international competitions dealing in the same field (BHP Limited, 2021). It is stated that the issuance of AASB 16 regulations will increase the value of transactions related to leasing and they are to be provided into the financial reports with greater importance will help the shareholders or any other person interested thereof in a more relevant way. With the help of the AASB 16 provisions, the factor of comparability can be implemented as the companies involved not only in energy or petroleum products but otherwise will be able to use the financial information in a better way to compare it with other close competitors (Xu, et. al., 2017).

It may also be noted that the AASB 16 provisions can impact the companies in a negative way also as a representation of lease transaction in the financial statements will represent the company as heavily indebted with lease obligation that the company is required to pay off. As a result of this, the companies might reduce the employee payment and can indirectly affect the bonus schemes (Xu, et. al., 2017). However, it is upon the companies to not get influenced by such extra debt and are required to ensure that the employees working under them do not get impacted by such leasing standards as such things demotivate the employees in their working and can affect them adversely.  It is to be noted that the main reason behind the issuance of standards in AASB 16 is that the regulations provided in earlier leasing arrangements that are IAF 17 were not described clearly and were inaccurate (BHP Limited, 2021). Therefore, with the implementation of AASB 16 the government tries to provide improved legislation so that it will help the companies as well as investors with better representation of financial statements.

Value of Lease

The lease value of the organizations is as follows:

BHP Limited:

  • AASB 16 of leases shows the amount of debt is increased by US $2.3 billion. The amount of lease as marked on June 30, 2019 is been noted at US $9.2 billion.
  • Rio Tinto makes the computation as per the AASB16, that shows the amount of lease is marked at US $ 43,686 million as marked in the financial year 2019.

Conclusion

It can be concluded that with the implementation of AASB 16 the government tries to provide improved legislation so that it will help the companies as well as investors with better representation of financial statements. It was observed that the effect of the implementation of AASB 16 norms and standards upon the financial records particularly in regard to two companies that is Rio Tinto and BHP Billiton in positive as well as negative way. It is stated that the issuance of AASB 16 regulations will increase the value of transactions related to leasing and they are to be provided into the financial reports with greater importance will help the shareholders or any other person interested thereof in a more relevant way.

References

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http://www.riotinto.com/investors/results-and-reports-2146.aspx 26 September. 2018].

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[online] Available at: http://file:///C:/Users/user/Downloads/J4144%20IFRS%20industry

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http://www.gaapdynamics.com/insights/blog/2016/08/16/top-5-biggest-changes-with-the-new-

lease-accounting-standard-(asc-842)/ [Accessed 26 Sep. 2018].

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asplus.com. (2016). Oil & Gas Spotlight — Production phase of the leases standard complete.

[online] Available at

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