Advance Financial Accounting: Rio Tinto Annual Report Analysis

This report provides an executive summary and detailed analysis of advanced financial accounting principles, focusing on the annual report of Rio Tinto Limited, an ASX-listed entity. It examines key accounting concepts like the going concern, business entity, and accounting period and cost concepts. The report delves into the measurement issues within the conceptual framework, particularly the trade-off between historical cost and fair value in asset and liability valuation. It evaluates the importance of relevance and representational faithfulness in financial reporting, supported by examples from Rio Tinto's financial statements, including asset measurement and revenue recognition. The report also discusses the implications of different measurement approaches and their impact on the comparability of financial information, especially concerning intangible assets, leases, and financial instruments. Finally, the report also explains how the company has adopted various measurement approaches as per the nature of assets and liabilities, causing the issue of inconsistency in the financial reporting of the company.

Advance Financial Accounting
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Executive Summary
The main objective of the report is to present an examination of the contemporary issue
in accounting by analyzing the annual report of a selected ASX listed entity. The report in this
context has presented an evaluation of the annual report of Rio Tinto Limited to determine the
accounting method used by it for financial reporting. Also, it has examined the need of achieving
a trade-off between relevancy and faithful presentation of financial information to meet the
qualitative criteria of these two fundamental features of conceptual accounting framework. This
is essential because the presence of both the characteristic is essential in the financial reports and
as such the accounting of assets and liabilities should be done in a manner so that both the stated
criteria’s are able to be met by the business entities.
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Contents
Executive Summary.........................................................................................................................2
Introduction......................................................................................................................................4
1: Description of accountings concepts and their application through providing examples of real
life company namely Rio Tinto.......................................................................................................4
Going Concern Accounting Concept...........................................................................................4
Business entity concept................................................................................................................5
Accounting period and cost concept............................................................................................5
2: Analysis of Issue of Measurement in the Conceptual Framework and Example from Selected
Company..........................................................................................................................................6
3: Evaluation of Relevance and Representational Faithfulness and their Importance in
Accounting for Assets and Liabilities..............................................................................................7
Conclusion.......................................................................................................................................9
References......................................................................................................................................10
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Introduction
The conceptual accounting framework is being developed and provided by the IASB to
direct and support the business entities cross the world in selection of appropriate accounting
concepts and approach for reporting of financial information. The ASX listed entities comply
with the IASB standard and therefore also integrate the use of qualitative principles for the
development of financial reports. As such, this report presents an evaluation of the accounting
concepts and policies implemented by an ASX listed entity, that is Rio Tinto Limited, a mining
company of Australia at the time of developing its financial statements. Also, it presents a
discussion regarding the measurement issue in accounting by stating examples from the selected
ASX listed entity. The importance of relevance and faithful representation as two major criteria
of financial reporting has been evaluated in the report by the use of selected ASX listed entity.
1: Description of accountings concepts and their application through providing examples of
real life company namely Rio Tinto
Below are some major accounting concepts that have been mandatory to apply by all
entities in world:
Going Concern Accounting Concept
This accounting concept holds that entity will continue to carry its activities for an
indefinite period and will not be liquidated unless there is required to do so. The simpler
meaning of this concept is that organization has continuity of life and it is based on assumption
that organization will not be dissolved in near future. Most of other accounting concepts use this
concept as the base to define their assumptions (Needles, Powers and Crosson, 2013). In order to
understanding going concern concept, it is good to take example of Rio Tinto entity. Rio Tinto
has deferred most of its expenses instead to charge them in same period such as depreciation of
property, plant and equipment. Some other items that are based on going concern concept are
provisions, contingent liabilities and deferred taxes (Mirza and Knorr, 2011).
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(Annual report, 2018)
Business entity concept
This concept provides that business entity and business owners are two distinct bodies.
So it is important that all the accounting transactions must be separate and classified accordingly.
When owner invest in business, such funds reflects as equity not as the assets of the company.
Rio Tinto has shown all the funds received from the shareholder’s as equity that means company
treats owners and business as separate bodies (Sadowska, 2016).
(Annual report, 2018)
Accounting period and cost concept
Accounting period concept holds that all the accounting transactions of same period will
taken at one place and profit must be calculated for the specified period. It means profit & loss
statement and balance sheet must be prepared for each period and all cost & income of particluar
peirod must shown in such period not in any other period. On the other hand, accounting cost
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concept provides entity must reflect all their assets at cost basis unless specific standard states to
value the asset on fair value (Wahlen, Baginski and Bradshaw, 2017).
2: Analysis of Issue of Measurement in the Conceptual Framework and Example from
Selected Company
The conceptual framework of accounting has been developed to provide guidance to the
preparers regarding the special accounting methods and policies to be used for development of
financial reports. The accounting framework has been developed by the IASB and therefore need
to be adopted by all the business entities across the world complying with the IASB standards.
The accounting framework has stated that the objective of providing financial reports to the
general users is to help them in economic decision-making ( Filipova, 2016). The framework has
also provided a standard framework to be used by businesses for identification, recognition and
measurement of its subsequent financial items. The conceptual framework is recognized as the
first framework in accounting that has helped in clarifying the concepts regarding measurement
approaches to be used in financial reporting. The framework has generally regarded historical
cost and fair value as the two main measurement concepts that are to be used by businesses for
the purpose of financial reporting (International Accounting Standards Board, 2016).
However, the issue of measurement that is present within the conceptual framework is
regarding the selection of an appropriate measurement approach for accounting of financial
items. The issue that exists in this context is whether the financial items such as assets or
liabilities should be identified and measured on cost basis or value basis as stated by the
framework. This is because cost measurement approach will tend to provide more reliable
information to the users while might not be largely effective in depicting relevant financial
information as it is past oriented (IFRS, 2017). However, the use of valuation method will
provide current value of a financial item on the basis of its active market but will not be reliable
in absence of present of an active market. Therefore, there is a conflict present between the uses
of two approaches for measurement in the process of financial reporting. The failure of the
framework top predict an accurate way for measuring the value of financial items is the main
issue that is present in the system of financial reporting (Gassen and Schwedler, 2010).
The financial analysts and investors are regarded to be fair value measurement approach
as more consistent with the objective of financial reporting in comparison to the historical cost
basis. This is because it reflects an accurate value of financial assets on the basis of its current
market conditions and thus helpful in providing trustworthy and relevant information to the
investors (Wolk, Dodd and Rozycki, 2016). The debate over measurement in accounting is
related to the shift of traditional basis of measurement, that is, historical cots, towards the use of
fair value. This is on the basis of changes in the nature of financial reporting due to development
of new ways of carrying business operations (ICAEW, 2016). The major challenge that is present
before the accounts in this regard is to develop an adequate method of measuring the value of
leasing, financial instruments, share-based payments as they do not have a historical cost.
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Therefore, more emphasis is placed on using fair value method of accounting as an adequate
approach to measure the value of complex financial accounting items. However, the question
that is associated with the use of fair value is regarding the anticipation of uncertainty in the
future outcomes to provide a fair picture of the current performance of an asset till measurement
date. As such, the IFRS has provided that prepares can adopt the use of different measurement
concepts for recognition of the value of the key financial items of an entity. The use of different
method of measurement makes financial information less comparable due to inconsistency in the
financial results over the period of time. The issue in measurement can also be elaborated by
providing examples from the financial report of the selected company of Rio Tinto Limited for
the year 2018 (Hopwood, 2013).
The fixed assets such as property, plant and equipment are measured at cost less
deprecation by considering the expected useful life. The recoverable mount of asset of less that
the depreciated historical cost them the assets are required to be written down at the recoverable
amount which is higher of its net fair value and value in use as per IAS 16. The inventories are
recognized at lower of historical cost and net realizable value. The company has also categorized
its financial assets into two categories, those that are measured at fair value or those held at
amortized cost(Annual report : Rio Tinto Limited, 2018). The measurement approach is selected
on the basis of the contractual terms of the cash flows. The financial liabilities are recognized at
fair value and are measured subsequently with the use of amortized cost. The share plans are also
recognized at fair value which is then stated as expense over the expected financial period
(Grüber, 2014).
Sales revenue is recognized on the basis of carrying value that is likely to be received
after the transfer of goods and services to the customers. The intangible assets are recorded
initially at costs and they are amortized over their useful economic lives. The accounting for
lessees is done as pre the IAS 17 standard that measures the lease liability at present value of
future cash flow obligations for meeting the retail payments. As the standard, a lessee needs to
identify all the use of assets and liabilities in a lease. The right of use of an asset depicts the lease
liability. There is also a need to recognize deprecation of the right of using assets and interest to
be paid on lease liabilities within the income statements. The total amount of cash paid and the
interest incurred for taking a lease should be stated in the cash flow statements. Therefore, it can
be said that Rio Tinto ahs adopted the use of various measurement approaches as per the nature
of assets and liabilities and this has resulted in causing the issue of inconsistency in the financial
reporting of the company(Annual report : Rio Tinto Limited, 2018).
3: Evaluation of Relevance and Representational Faithfulness and their Importance in
Accounting for Assets and Liabilities
The conceptual accounting framework has presented two major qualitative principles that
need to be present within the financial reports for increasing their usefulness in economic
decision-making of investors. The relevancy as stated by the conceptual accounting framework
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depicts that the financial information should be capable to support the decision-making of the
end users. The financial information should provide feedback and predictive value to the end-
users of an entity. The predictive value denotes that an entity must disclose the financial
information that is able to provide an estimate of its future cash flows. For example, the financial
information regarding the financial figures of sales and revenue that is disclosed within the
income statement of a company represents the predictive value. Also, the confirmatory value
denotes providing information that is able to confirm the past evaluations of a company. The
financial information by having predictive and confirmatory value must be able to make a
difference in the decision-making of the users.
On the other hand, faithful representation of information denotes that it should be
complete, free from any type of error and should be materially correct. The complete aspect of
the financial information signifies that a reader must be able to gain a clear picture of the
financial position of an entity (Bellandi, 2017). The error-free characteristic of the financial
information denotes that it should not have any error and depicts a fair view of an entity. The
relevance and faithful representation of financial information can be regarded as the two major
qualitative principles that need to be used by preparers during the time of developing and
presenting the financial information. It has been stated by the conceptual accounting framework
that an entity need to ensure that both the fundamental qualities must be present within the
financial reports and the selection of an accounting alternative must be based on the criteria of
meeting the reliability and relevancy of financial reporting (Ashford, 2011).
However, the major problem that exists in this regard for developers of financial report is
to meet both the qualitative criteria’s adequately. This is because making the financial
information too reliable can negatively impact its relevancy and vice-versa. For example,
accounting of assets and liabilities using the cost basis might result in making the financial
information more reliable but can have a negative impact on its relevancy. This is because
historical cost method of accounting can provide information on the basis of past evaluations and
therefore is not very useful for the investors to determine the future financial performance of an
entity. On the other hand, the use of fair valuation method can result in making information more
relevant for the investors to aid economic decision-making but make it less reliable for auditors
as it is based on future predictions and might not represent actual value of assets and liabilities in
the condition of presence of market volatility (Dye and Sridhar, 2010).
Therefore, the business entities are adopting the use of mixed model of accounting and as
such account certain assets and liabilities at historical cost while some are measured at fair value
of accounting. This helps them to achieve a tradeoff between both qualitative characteristics of
accounting for meeting the interest of its various stakeholders. The financial analysts and
investors regards relevancy to be most important criteria for accounting of assets and liabilities
whereas auditors regard representation of information in an effective manner as an important
criteria for accounting of financial items (Albrecht, Stice and Stice, 2010). The implications of
both these qualitative characteristics in developing high quality financial reports can be depicted
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by analyzing the annual report of the selected company. Rio Tinto has also emphasized on
achieving a tradeoff between the two qualitative principles of conceptual framework by placing
emphasis on relevance in accounting of certain assets while on faithful presentation in
accounting of other assets. The company has presented the financial instruments, financial assets
and liabilities at fair value. This is because the use of fair valuation method can help in accurate
identification and recognition of these assets and liabilities due to presence of their active
market. On the other hand, the non-current assets and liabilities are measured at historical cost
due to absence of their active markets. Thus, it has adopted the use of mixed model of
accounting for measuring the value of assets and liabilities to ensure that the investors are able to
predict the future financial performance and auditors are able to assess the materially correctness
of the financial information (Annual report : Rio Tinto Limited, 2018). The fair valuation
approach can help in providing an estimate of the future cash flows associated with an asset
while historical method can help in confirming the present value of an asset on the basis of past
evaluation (Burlaud, 2013).
Conclusion
The report has inferred that business entities such as those listed on ASX that are
preparing their financial reports as per the IASB standards need to comply with qualitative
principle of conceptual framework. It has been examined on the basis of financial report of Rio
Tinto Limited, an ASX listed entity, that it has adopted qualitative features of accounting
framework for developing high quality financial reports. However, it has integrated the use of
mixed model of accounting for reporting of value of its assets and liabilities to achieve
congruence between the two above mentioned criteria of financial reporting.
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