Individual Assignment

On

ACCOUNTING Theory and Issues

Submited By: Yousaf

Raza
11501735

TABLE OF CONTENT

S.No. Particulars
1
2
3
4
5
6
7
8
9
10
11
12

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INTRODUCTION
REMUNERATION POLICY & REPORT
GENERAL PURPOSE FINANCIAL REPORTS (GPFR) An Analysis
INVENTORY
ACCOUNTS RECEIVABLE
DEPRECIATION
INTANGIBLE ASSETS
CONTINGENT LEGAL LIABILITIES
LIMIT RATIO

UNDERSTATED EXPENSE & OVERSTATED

REVENUES
PRUDENCE

CONCLUSION

REFERENCES

Page
No.
3
3-5
5-15
15-16
16-17
17-18
18-20
20
20
20
21
21

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1. INTRODUCTION
This report articulates the financial performance of the chosen company Rio Tinto as per the various
crucial financial parameters including remuneration, report, inventory, accounts receivable, prudence and
General Purpose Financial Report (GPFR). The report comprises the comparison of two or more
companies over these terms, hence the other company of comparison would be Woolworths Limited. The
company Rio Tinto is huge global company dealing in mining & metals with different production
locations and various geographical markets. The company is running for more than 140 years and has the
human capital of around 55000 employees with world-wide presence in 40 countries. ( Pizzey, 2001)

2. REMUNERATION POLICY & REPORT

The company like Rio Tinto has the long term projects as related to mining, developments, extraction
which yields the results after a certain point of time. Hence, the performance measures are also linked &
established accordingly. The remuneration of executives & executive directors is the outcome of the
performance and efforts to be made as per the strategy of the group. The remuneration policy is complied
with the applicable legislation of UK & Australia. The incentive plans are performance related plans
including short term incentive plan (STIP), long term incentive plan (LTIP), performance share plan
(PSP), Bonus deferral plan (BDP) with the fixed salary, superannuation benefits and other perquisites.
The fixed element of salary is annually reviewed with increment of 9% maximum to retain the
competitive human resources. However, the executives salary may be exceptionally increased on account
of internal promotions or enhancement of responsibilities.
The related Key performance indicators (KPIs), weighing and the relative targets are settled at the
commencement of the period. Under the STIPs, the achievement of target performance may lead to bonus
of 120% & 100% of base salary for executive directors and other executives respectively. Sometimes, the
upward & downward adjustments can be made within the approval of committee in order to make the
comparison between the actual performance & target performance.

The bonus deferral plan is related to shareholders interest under which the 50% benefit of STIP is
provided in form of deferred shares and rest of the part is delivered in cash. The performance share plan is
3

the new incentive plan approved by the shareholders in the AGM of 2013 which links the reward of
executives to the shareholders returns in order to strives the long term growth of the company. The award
would be computed & assessed by the independent consultants Willis Towers Watson. The award will
be denoted by the expected value of maximum 50% of face value of 438 per cent of base pay which
comes 219%. The highest threshold value will be 22.5% of face value (22.5*438) i.e. 98.6% of base
salary and the actual reward may vary from the performance of time to time. The incentive system has the
long term horizon of 5 years and based upon the comparison of performance of total shareholder returns
relative to Euro money global mining index & enhancement in EBIT with comparison to global mining
players. (Rio Tinto Annual Report, 2015)

(source :Rio Tinto Annual Report, 2015)

3. GENERAL PURPOSE FINANCIAL REPORTS (GPFR) - An

Analysis
The general purpose financial reports (GPFR) are the reports to be prepared by each reporting entity in
accordance with AASB 101 in order to articulate the financial performance of the business. The financial
performance of the entity should be reported in the prescribed format to make it comparable with the
historical data of the entity itself and the other competitive entities. The set of general purpose financial
reports consist majorly four types of reports i.e. Income statement, balance sheet, cash flow statement and
statement of changes in equity. The accounting standard AASB 101 prescribes the format of presentation
of financial statements which shall serve the general purpose of financial statement.
The GPFRs communicate the financial position of the business to its stakeholders in general. Various
stakeholders make the key decisions on the basis of these reports. For instance, the prospective investors
for new investment & existing investor for continuing the investment with further investment plans shall
consider, study and analysis the financial statement in order to assess the profitability, returns, risk & long
term growth. It is also used by lenders to understand the credibility status of the business with their
repayment capacity. Similarly, it helps the management to determine the achievement of targets, strategies
and the growth from the previous years as well and to layout plans & future policy formulations.
Due to its huge relevance & significance in key decision making, the chances of its manipulations and the
communication of incorrect financial position may become higher. Sometimes, the unrealized profits may
be shown to make undue increase in profitability to attract the investors and collection of funds. This kind
of fake positions may be portrayed to borrow the more funds in spite of having low margins to make
repayments. The management may hype the profit by making unnecessary changes in policies &
procedures without disclosing the followed inconsistency in notes to accounts. In this way, the financial
reports may be prepared for profit motive with the ignorance of accounting standards which mislead the
stakeholders and do not serve the general purpose. It should be noted that this kind of deviation and
misleading of information may attract the huge penalties & defamation of the organization which is a long
term loss.
The financial reports of Rio Tinto are presented below:

(source :Rio Tinto Annual Report, 2015)

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The financial reports of Woolworths Limited are as follows:

(source :Rio Tinto Annual Report, 2015)

11

(source :Rio Tinto Annual Report, 2015)

12

13

(source :Rio Tinto Annual Report, 2015)

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(Sources: Rio Tinto Annual Report, 2015)

4. INVENTORY
The inventory is the key component of current asset which affects the liquidity position as well as
profitability position of the business under the income statement. The misstatement of inventory may
mislead the users of financial statement. Although the inventory is not readily convertible current asset
but still backed the short term solvency position of the business. The excessive holding of inventory may
cause higher storage cost and minimum holding may lead to danger of stock out position. Hence, it should
be maintained at the equilibrium level to avoid the excess blockage of funds with enough availability of
stock as required. The inventory is a vast term which includes various types i.e. raw material, store &
spares, work-in-progress and finished products. The accounting standard AASB 102 describes the method
& treatment of inventory. The inventory should be valued lower of the cost or net realizable value (NRV)
which is also driven by the accounting concept of conservatism and doesnt account the unrealized profit.
However, the inventory shall be sold after adding margins but the margins are uncertain until the sale
occurred. Hence, the prudence is followed by valuing the inventory at the least of two. The overstatement
of inventory shall mislead the overstated profits and better liquidity position of the business which shall
ultimately affect the business position & stakeholders. (AASB 102, 2009)

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5. ACCOUNTS RECEIVABLE
The accounts receivable is the readily convertible current asset and seems the major factor in quick liquid
position of the entity. The accounts receivable should be valued at fair value and clearly stated the
doubtful debts with impairment losses if any. The realization of accounts receivable is related to their
respective age group and according to which the doubtful or bad debts can be determined. The ageing of
debtors is required to identify the collection status like less than 30 days, more than 30days, less than 90
days, more than 90 days and overdue. Sometimes, the receivables are recoverable after a long period and
marked as non-current asset due to industry norms & practices. The lenders providing the short term
credit facilities consider the valuation of trade receivables and the overvaluation may mislead their
decision. The short term credit facilities are based on the hypothecation of inventory & accounts
receivables. The AASB 139 states that the impairment losses should be clearly recognized & disclosed in
the statements separately. (AASB 139, 2010)

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(source :Rio Tinto Annual Report, 2015)

6. DEPRECIATION
The depreciation is the allocation of the cost of the asset as per the pattern of consumption of economic
benefits. The depreciation is an expense and reflected in income statement & balance sheet as well. The
method of depreciation and the related policies should be consistently followed and the significant
changes should be clearly mentioned in the notes to financial statements. The understatement of
depreciation by frequent and unnecessary changes in the method may lead to overstatement of profit
which ultimate leads to non compliance of AASB and provide the mislead information to stakeholders.
The prudence concept should be followed while selecting the method of depreciation as prescribed under
AASB 116 like straight line method, reducing balance method and others. ( AASB 116, 2009)

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(source :Rio Tinto Annual Report, 2015)

7. INTANGIBLE ASSETS
The intangible assets are recognized after amortization and impairment. This category consists the
intellectual property, technology, goodwill and others. In the case of Rio Tinto, the intangible assets are
classified under the category of exploration & evaluation, trademarks, patented & non patented
technology and other intangible assets. The contract based intangible assets majorly includes the efficient
water rights which have the indefinite lives but annually reviewed for impairment. The definite lives of
intangible assets are determined to amortize the cost over its useful life on straight line basis or
production basis. (AASB 138, 2015)

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(source :Rio Tinto Annual Report, 2015)

The accounting standard AASB 117 describes the identification of leases under the operating & finance
lease with the further rules for recognition & accounting of lease rentals and relevant disclosures. The
company has certain finance & operating lease with respect to mines, explorations at different locations.
The company has also disclosed due payments under different time periods for finance leases.

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(source :Rio Tinto Annual Report, 2015)

8. CONTINGENT LEGAL LIABILITIES

The contingent liabilities are those liabilities which are to be paid at the occurrence of certain event. The
liabilities are contingent and uncertain whether to be paid in future or not. The contingent liabilities
should be properly disclosed and make provisions for the same in financial statements.

(source :Rio Tinto Annual Report, 2015)

The group has also contingent assets in form of insurance claims but the realizable amount can be
estimated with accuracy. There are certain guarantees & indemnities which may create the possible
outflow in future and create contingent liabilities. However, the joint ventures & associates of the group
dont have any material level contingency.

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9. LIMIT RATIO
This ratio is considered by the lenders before sanctioning the financing facility. It determines the total
capacity of the borrowings of the firm in terms of credible position & financial leverage and then identify
the capacity utilized in form of sanctioned financing facility. The present credit utilization capacity of the
company is denoted by the limit ratio and helps to estimate that how much additional finance can be
availed by the company. The capacity is assessed on the basis of repayment capacity, level of financial
leverage, burden of fixed financial burden and the additional finance. The proposed investors and lenders
favor the organization having lower limit ratio.

10.

UNDERSTATED EXPENSE & OVERSTATED REVENUES

The financial statements can be manipulated to represent the mislead & unfair view of financial position
of the business. The understatement of expenses and overstatement of revenues shall give a fake
profitable position of the company which may not be realized in future and make unexpected losses. This
manipulated view of undue profits may attract the investors and lenders short term basis and get the
funds. The understatement of expenses or overstatements of revenues are non-complied with the
accounting standard and also influence the decisions of key stakeholders adversely. It also betrayed the
basic principle of accounting i.e. conservatism or prudence.

11.

PRUDENCE

The concept of prudence or conservatism is the fundamental of accounting which provides the true & fair
view of financial statements. It states that accounting of each transaction and further provisions shall be
made with the caution of recognizing the expected or foreseeable losses and do not account the unrealized
profits. It is always a safe play to estimate the profit at lower side and helps to make wise decisions for
the investors as well. The applicability of prudence is required while opting for the policies of estimation,
accounting and methods of depreciation. The consistency should be followed until the changes are
required to follow the prudence concept. (Kiabel, 2011)

12.

CONCLUSION

The entire report discussed the applicability and compliance of accounting standards with the example of
Rio Tinto, the global mining company. The impact of non compliance of accounting concepts and AASBs
is assessed with respect to different components of financial statements like inventory, depreciation,
leases, intangible assets, account receivables and others.

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REFERENCES

AASB 101Presentation of Financial Statements, 2015 URL:

www.aasb.gov.au/admin/file/content105/c9/AASB101_07-15.pdf

AASB 102 Inventories,2009 URL:

www.aasb.gov.au/admin/file/content105/c9/AASB102_07-04_COMPjun09_01-09.pdf

AASB 116 Property, Plant & Equipment,2009 URL:

www.aasb.gov.au/admin/file/content102/c3/AASB116_07-04_ERDRjun10_07-09.pdf

AASB 138 Intangible Assets, 2015 URL:

www.aasb.gov.au/admin/file/content105/c9/AASB138_08-15_COMPoct15_01-18.pdf

AASB 139 Financial Instruments: Recognition & Measurement, 2010 URL:

www.aasb.gov.au/admin/file/content105/c9/AASB139_07-04_COMPoct10_01-11.pdf

Kiabel, B. D. (2011) Accounting Principles Port Harcourt Mgbaa Printing Press.

Pizzey, A. (2001) Accounting and Finance A Firm Foundation London: Continuum

Rio
Tinto
Annual
Report,
2015
.(Online).
http://www.riotinto.com/investors/results-and-reports-2146.aspx

Available

at

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