Executive long-discussed standard: IFRS 16 Leases that will

Executive summary

This paper aims at comparing AASB117 and
AASB16 and analysis of transition in a converged accounting standard for leases.
In January 2016, IASB issued another important and long-discussed standard:
IFRS 16 Leases that will replace IAS 17, which means that for many Australian
entities the changes will be effective for 30 June 2020 year-ends. The new
rules are expected to impact trillions of dollars of lease commitments
worldwide, with the biggest impact is expected to be in the retail, aviation,
mining and transport sectors. Therefore, as a mining company, Rio Tinto are
likely to be affected. This paper will explore what actions Rio Tinto should take
to prepare for the application of the new standard and change their model.

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Rio Tinto under the AASB 117 accounting
standards

According to AASB117, a lease is
classified as a finance lease and an operating lease. The finance lease has to recognize
the leased asset and a corresponding lease liability a lease which transfers
substantially all ownership risk and rewards, with or without eventual transfers
of the legal title: Risks of ownership include obsolescence, idle capacity,
uninsured damage etc. Reward of ownership include benefits from use of the
asset, appreciation in value of the asset. The definition of an operating lease
is that, A lease that does not transfer substantially all the risks and rewards
incidental to ownership of an underlying asset. AASB 117
requires companies display the distinction between operating and finance
lease assets for accounting by lessee, so when general investors check Rio
Tinto’s annual report could see their distinction between finance leases and
operating leases.

As a large multinational company, financial
leasing is mostly, which involving mining equipment, office buildings, land,
and maritime transport etc. Company should classify the lease first under AASB
117, and at the end of each year, it simply books expense in profit or loss.

In their principal accounting policies, AASB
16 with not yet endorsed by the EU is mandatory in 2019. This standard will have
impact on their group’s earnings and shareholder’s funds at transition and in future
years. In this year, they only recorded total and timing of the MLP for non-cancellable
operating leases and a general description of lessee’s significant leasing arrangements
in operating leases. For finance leases. They disclosure in the financial
statements in accordance with AASB 117 Leases and point the page of notes, which
included reconciliation between total and present value of the future MLPs in time
bands of one year, two to five years and beyond five years; contingent rents; general
description and carrying amounts.

 

AASB16 changes in accounting
standards

Under IFRS(AASB) 16, there are no longer
any differences between finance leases and operating leases. Lessees will now bring
to account a right-to-use asset and lease liability onto their balance sheets
for all leases. In practice, this means that the vast majority of operating
leases as defined in the current AASB 117 Leases that do not currently affect
the balance sheet will be required to be capitalized on the balance sheet after
IFRS 16 is adopt. Its main purpose is also to eliminate off-balance sheet
financing, which means more assets and liabilities will show on balance sheet.

The interpreting from AASB 16, they answer
why they have issued this Standard,” The
previous accounting model for leases required lessees and lessors to classify
their leases as either finances leases or operating leases and account for
those two types of leases differently. That model was criticised for failing to
meet the needs of users of financial statements because it did not always
provide a faithful representation of leasing transactions. In particular, it
did not require lessees to recognise assets and liabilities arising from
operating leases.” So that, AASB 16 replace AASB 117 could better meet the
needs of users of financial statements and provide a clearer and direct view of
the company’s assets and liabilities.

From accounting entries, the elimination
of the classification of leases may cause more expense, because the new model
is adopted, and the pattern of expenses has changed. There are loads of interest in the beginning of the
lease, but smaller expenses at the end of the lease when the lease liability is
amortized.

In total, both models have the same profit
or loss impact over total lease term. It is foreseeable that Rio Tinto as a
mining industry would has a great deal impact, because many debts and assets are
calculated and recorded to the accounting entries of balance sheet, which are
not required to disclose under AASB 117,

 

Change the impact on the company

It is only lessee accounting that is being
substantially reformed, with the lessor accounting requirements contained in
AASB 16’s predecessor, AASB 117 Leases remaining largely unchanged in its replacement.

Following the new bookkeeping method,
non-current assets will rise, so ROA ratios will drop as the overall asset
increase. Non-current liabilities rise, and leverage ratio will become larger, which
means the debts of company are increasing. Investors would doubt about the
company’s ability of going concern and their solvency, and reduce their
confidence in the company’s profitability. This state liabilities increased is
changed from the different accounting methods, so the company’s profit and loss
cannot think simply and estimate the number from balance sheet. There is obvious
difference if compared the number recorded by AASB 16 and AASB 117 in their financial
year.

Depreciation and interest charges may
exceed lease payment in the early years of lease, lower profits and eps in
early years. These are possible reasons make change in financial statement.

General investor does not
want to delve deeply into your company when
they are seeking their interesting industry. He also hoped to know from the
financial statements whether the company is profitable, he doesn’t spend much
time to know why company’s profitability is diminishing or your debt increases,
and does not need to distinguish between finance leases and operating leases.
They only need to know the company’s overall operating conditions. However,
company’s management is different, they need to understand the company in
depth, know the company’s operations and make decision to improve company
development. They need more data analysis to support their decision and strategies,
not only simply look at balance sheet figures displays a positive number.

 

Recommendation

For the company as a lessee, Rio Tinto
should more consider term of leased, the allocation of long and short lease, lease
of low value asset. As a multinational corporation, Rio Tinto also needs to
consider the cost of transportation and currency exchange, and at the same time
it is subject to the local or host country economic conditions, they need build
integrated development strategy.

From the annual report note 24, they clearly
show that debts have drop in 2016 compared to 2015, possible reason are recovery
in the mineral market or the US dollar’s strength, the development of new
energy needs more minerals, the dollar can reduce foreign exchange losses. Furthermore,
each country’s systems and laws are different, company need to take into
account the depreciation and tax rates. If leasing with the government, the
lease term need to decide on long or short rent, which are very complex
decision-making process, the right-to- Use asset needs to be controlled in a
profitable range for companies, and they need to gather more information to
analyze the company’s operations situation decision.