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1. As an Auditor for BHP for 2017 financial year are there regulation, restrictions or disclosure requirements etc. that has implications for your firm if you provide the requested advice. If so, please discuss the requirement and how you would resolve it.

2. Why has the leasing standard been changed? What will change? What does it mean for BHP and Rio Tinto? And how AASB 16 would benefit and/or disadvantage the BHP and Rio Tinto?

3. What effect does AASB 16 has on BHP and Rio Tinto’s income statement, balance sheet and cash flow statement? What does it mean for users of BHP and Rio Tinto’s financial statements? (Note: Compare and discuss relevant ratios where applicable. Use 2017 Annual Report for both BHP and Rio Tinto for comparison. Attach as Appendix 1 extract from the financial statements that you have used. Compare and discuss ratios in the body of your discussion and attach your ratio calculations including any formula for both companies in appendix 2.)

4. How have these two companies reported their environmental and social aspects such energy use and efficiency, carbon emissions, etc.? Is there any regulatory requirement for such reporting? If so, summarise the requirements and discuss what they have reported? If there is no regulatory requirement, is there any evidence that these mining companies have reported/disclosed any environments and social information, if so, summarise how and what is reported/disclosed?

5. Evaluate whether overall, AASB 16 would result in reporting that would be more useful to users of BHP and Rio Tinto’s financial statements?

6. Summarise your discussion for the Chief Executive Officer (CEO) of the investment company who is from a non-accounting background.

Background Information on Leasing and the New Standards

Leasing is becoming an important solution of financing a fact which has seen a wide use. This is because it enables a company to make use of the property and equipment without having to incur substantially large cash outflows to access them. The flexibility and the benefits of a lease in terms of providing a cover for obsolesce give the lessee the chance of evading residual value risks. Since leasing is the only way of obtaining the physical use of an asset without having to purchase it, it has become the widely used financing method among big corporations in Australia.

From contemporary definition, a lease is a contract where one party who is the leaser, conveys his or her own property in form of either land or services to be used by another party called the lease for a specified period of time stipulated in the lease agreement in return for a specific payment amount (Deegan et al., 2012, np; Chapple, 2016, pp. 365). However, the changed definition of a lease would mean that for a contract to be regarded as a lease, the lease agreement should enable the leases to control the use of the leased asset for a specified period of time and at the same time obtaining substantial economic benefits from it. The move by Australian Accounting Standards Board to release the new lease standards (AASB 16) in February 2016 is intended to bring a general overhaul in Lease Accounting.

Beginning the financial period 1st January 2019, many Australian entities will have to abide as per the new regulations outlined by the Australian Accounting Standards Board. The new regulations purposes to scrap the classification of the operating lease and bring all the leases together with their liabilities to the company’s balance sheet. This paper seeks to determine the reasons why the leasing standard has been changed, investigate the effect of AASB 16 on BHP Billiton and Rio Tinted Limited’s financial statements, evaluate whether the overhaul in the leasing standards would be more useful to the financial statement users of Rio Tinto and PHB and identify the regulations that can have implications for the auditing and assurance firm (KPMG) as a result of providing consultancy services to a client on the effect of AASB 16 on entities financial statements.

Just like any other companies in Australia, the implementation of the AASB 16 is expected to pose a number of operational and financial challenges to the financial statements of BHP Billiton Limited and Rio Tinto Limited. These organisations have a big number of large lease assets, many service contracts embedded with leases which hold complex and long-term leases (Bdo.com.au, 2018, np.). As of now, many companies have not fully progressed in the process of implementing AASB 16's standards despite much efforts that are intended to bring a change in the accounting for leases.

Reasons Behind Changing of the Leasing Standards by AASB

 In order to harmonize the Australian Accounting standards with those of the International Financial Reporting Standards, the Australian Accounting Standards Board sought to change the lease standard AASB 16 to conform with IFRS 16. The change seeks to remove the concept of the operating and the finance lease for leases and replace them with a single lease accounting model. Unlike before where leased property and equipment were recognized off the balance sheet, the new standards require that leases should be accounted as a right for-use (ROU) where the leased assets together with the associated lease liabilities will be reflected in the balance sheet (Michelle Gibbs, 2018, np.). The changes are also intended to bring more transparency in the organization regarding the commitments to leases and at the same time changing the financial statement metrics such as returns on capital employed and earnings before interest and taxes. The main reason behind the changing of the leasing standards by AASB was, therefore, to bring significant changes to the financial reporting practice as a result of the adoption of International Financial Reporting Standards (IFRS).

Despite the fact that the impact of the AASB leases standards has not yet been felt by a number of entities in Australia, there is an extensive coverage of the effects of the changes that would be brought by the functioning of the standard. The new leases AASB 16 standard has a number of effects and implications on both the income statement and the balance sheets of BHP Billiton and Rio Tinto. First of all, it means that the implementation will have to change many aspects of lease accounting even beyond the financial reporting context (Martin, 2017, np.). The processes, controls and systems of recognition and recording of leases will have to be modified so as to ensure the lease records are complete and accurate. Both companies will have to assess the impacts of the leasing strategy by managing the related accounting items such as debt covenants, impairment testing and tax-affected accounting items ("AASB 16: Leases", 2018, np.). The changes posed by AASB 16, therefore, requires a lot of time and effort from the side of the companies in order to implement them.

The new standard means that there will be no more operating leases as per IFRS 16 unless in certain exceptions where the lessee decides not to apply the requirements of IFRS 26 because the lease contract is made of items of short-term leases or the property is of very low value. The lease payments for assets of low values will, however, be recognized on a straight-line basis over the specified lease term. The new AASB 16 also requires that all the leases (unless an exception) should be capitalized in the balance sheet by recognizing a right of use of the asset together with lease liability for the present value of the obligation (KPMG, 2018, np.). This means that, there will be no more rental expenses (prepared on a straight line basis) when it comes to operating lease costs because all the leases will be incurring an upfront-end loaded expense which compromises the method of depreciation on the right of use of the asset and hence the interest on the liability of the lease.

Effects of AASB 16 on the Financial Statements of BHP and Rio Tinto

During the initial determination of the of the right of use of the asset and the lease liabilities to be paid, the AASB 16 standard requires that the non-cancellable costs such as inflation-linked expenses, payment for option periods at which the company is certain to make use of the property will have to be included in arriving at the present value figure of the lease. This further means that the lessees of retail premises who were required to pay turnover of contingent rental costs and those who were required to make contingent rental payments will be relieved of capitalizing the right of use of the asset but will expense the cost in the profit and loss statement as it used to be the case (Aasb.gov.au, 2018, np.) The overall requirements of AASB 16 in regard to the rights–to-use the assets and the lease liabilities is to recognize them in the balance sheet unlike before where it was regarded as an operating lease. The effect of this distortion of the balance sheet change is that the asset base is going to be significantly increased while the debt figure is also going to increase.

Since the standard will remove rent as operating expense but as a depreciation expense, the EBITDA of the lessees will be affected tremendously. For instance, instead of recording the rent expense, the lessees will have to recognize the depreciation expense (rent) on the right-to-use the property and interest in the balance sheet as the lease liability (KPMG, 2018, np). The effect of this is that the EBITDA will increase because the previous costs that were included as operating expenses will be added back as interest and depreciation and transferred to the balance sheet as a liability. This can be appealing to you as the investor because the increase in EBITDA in an entity suggests good financial performance which might not be the case. If EBITDA is the only indicator of a firm’s performance, a lot of care should be taken as it is most likely that it will be ‘’grossed up’’. However, in my view, I believe that the overhaul brought about by the AASB 16 standards would result in a reporting that would be beneficial to the users of both Rio Tinto’s and BHP’s Financial statement.

The new AASB 16 standard is going to affect all of the most commonly used financial ratios such as the asset turnover, the interest cover, ROCE, EPS, ROE and the operating cash flows. First of all, the balance sheet is going to grow while the capital and gearing ratios decrease (Mills, 2017, np.). Since BHP and Rio Tinto will be involved with the leasing of ‘big tickets' assets, the companies are going to be greatly affected. As a result, the changes will also affect the credit ratings, borrowing costs and loan covenants which might result in behavioural changes for BHP and Rio Tinto. The effects will also compel both organizations to reassess their lease agreements over make or buy decisions. Appendix 1 shows the financial statements for BHP AND Rio Tinto which are heavily affected by the lease standard changes once it becomes effective because the company's do not fall under the exceptions of the ‘low-value assets' which are not recognized on the balance sheet ((BHP Billiton, 2018 np.; Riotinto.com, 2018, np).

The Main Implications of AASB 16 Standard to the Lessees

As a way of showing openness, diversity relationships and mutual concern for the community in which they operate, BHP and Rio Tinto have disclosed and reported about the social and environmental aspects of their operations. Apart from the major Sermarco dam disaster that really discredited the reputation of BHP Billiton in 2015, the corporation has been determined to put health and safety of the workers and the community ahead trough environmental responsibility by supporting the communities in environmental conversation. (BHP Annual Reporting, 2017, pp 30; Riotinto.com. Annual report, 2017, pp28).  Mining companies in Australia are required to adhere to the sustainability reports frameworks developed by GRI and OECD. The regulatory requirements have therefore compelled the companies to report and disclose all the environmental impacts that their operations bring to the environment. BHP have tried to adhere to the regulations by reporting their decarbonization strategies which are a move towards an environment with low-carbon emission. The company according to their 2017 reports is concerned about the environmental risks that come with increased diversification of energy sources (Globalreporting.org. BHP Sustainability Report, 2017, np).

Summary

In Summary, the new AASB 16 standards are expected to bring an overall overhaul in the accounting for leases. As a matter of fact, the introduction of a single lessee accounting model where the company seeking a lease is expected to bring all the assets and liabilities of the lease to the balance sheet is a drastic change to many companies. Rio Tinto and BHP Billiton is not an exception to this. Moreover, the recognition of a leased asset will change from an operating lease to the right-of-use of an asset a term which represents that the company has acquired the right to use a certain leased asset and will be paying lease liabilities according to the terms of the lease agreement. This means that the changes proposed by the new standard are intended to enhance the disclosures of leases for both the lessors and the lessees thereby improving the information being disclosed in the annual reports for companies exposed to leased properties as discussed above.

References

KPMG. (2018). AASB 16: Leases. [online] Available at: https://home.kpmg.com/au/en/home/insights/2017/04/aasb-16-leases-standard.html [Accessed 3 May 2018].

Aasb.gov.au. (2018). Accounting standards. [online] Available at: https://www.aasb.gov.au/Pronouncements/Current-standards.aspx [Accessed 2 May 2018].

BHP Billiton. (2018). BHP Annual Reporting 2017. [online] Available at: https://www.bhp.com/investor-centre/annual-reporting-2017 [Accessed 2 May 2018].

Chapple, S. (2016). Book review: Aiming for Global Accounting Standards: The International Accounting Standards Board, 2001–2011CamffermanKeesZeffStephen AAiming for Global Accounting Standards: The International Accounting Standards Board, 2001–2011, Oxford: Oxford University Press, 2015, 688 pp; 9780199646319. Accounting History, 21(2-3), pp.364-365.

Deegan, C., Doupnik, T., Ivancevich, J., Luthans, F., Mintz, S., Lawrence, A. and Steiner, J. (2012). ACCG399. North Ryde, N.S.W.: McGraw Hill.

Globalreporting.org. (2018). BHP Sustainability Report 2017. [online] Available at: https://www.globalreporting.org/Pages/FR-BHPBilliton-2017.aspx [Accessed 3 May 2018].

Martin, R. (2017). The effects of the new leasing standard are wider than you might think. RSM Australia. Retrieved 2 May 2018, from https://www.rsm.global/australia/insights/ifrs-news/effects-new-leasing-standard-are-wider-you-might-think

Michelle Gibbs, E. (2018). AASB 16: Overhaul of lessee accounting effective 2019. [online] KPMG. Available at: https://home.kpmg.com/au/en/home/insights/2017/04/aasb-16-fundamental-overhaul-lessee-accounting.html [Accessed 3 May 2018].

Mills, J. (2017). Thoughts on the impact of changes to AASB 16?. [online] Intelligent Investor. Available at: https://www.intelligentinvestor.com.au/thoughts-on-the-impact-of-changes-to-aasb-16-1878181 [Accessed 2 May 2018].

Bdo.com.au. (2018). New leases standard. [online] Available at: https://www.bdo.com.au/en-au/accounting-news/accounting-news-february-2016/new-leases-standard [Accessed 2 May 2018].

KPMG. (2018). AASB 16: Leases. [online] Available at: https://home.kpmg.com/au/en/home/insights/2017/04/aasb-16-leases-standard.html [Accessed 2 May 2018].

KPMG. (2018). Financial Reporting & Accounting Standards. [online] Available at: https://home.kpmg.com/au/en/home/services/audit/financial-statement-audit/financial-reporting-accounting-standards.html [Accessed 2 May 2018].

Riotinto.com. (2018). Annual report. [online] Available at: https://www.riotinto.com/investors/annual-report-16577.aspx [Accessed 2 May 2018

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