Corporate Accounting: Fair Value Reporting - BHP Billiton & Rio Tinto

This assignment provides a comprehensive analysis of fair value reporting in corporate accounting, including an essay discussing the importance and controversies surrounding fair value accounting (FVA). It also includes a case study comparing the fair value reporting practices of BHP Billiton and Rio Tinto, focusing on their approaches to fair value hierarchies, asset valuation, and the use of the Fair Value Less Cost of Disposal (FVLCD) method. The analysis highlights both similarities and differences in how the two companies apply fair value principles in their financial reporting, offering insights into the practical application of these concepts in large, multinational corporations. Desklib offers a range of solved assignments and past papers to aid students in their studies.

qwertyuiopasdfghjklzxcvbnmqwertyui
opasdfghjklzxcvbnmqwertyuiopasdfgh
jklzxcvbnmqwertyuiopasdfghjklzxcvb
nmqwertyuiopasdfghjklzxcvbnmqwer
tyuiopasdfghjklzxcvbnmqwertyuiopas
dfghjklzxcvbnmqwertyuiopasdfghjklzx
cvbnmqwertyuiopasdfghjklzxcvbnmq
wertyuiopasdfghjklzxcvbnmqwertyuio
pasdfghjklzxcvbnmqwertyuiopasdfghj
klzxcvbnmqwertyuiopasdfghjklzxcvbn
mqwertyuiopasdfghjklzxcvbnmqwerty
uiopasdfghjklzxcvbnmqwertyuiopasdf
ghjklzxcvbnmqwertyuiopasdfghjklzxc
vbnmqwertyuiopasdfghjklzxcvbnmrty
uiopasdfghjklzxcvbnmqwertyuiopasdf
ghjklzxcvbnmqwertyuiopasdfghjklzxc
vbnmqwertyuiopasdfghjklzxcvbnmqw
CORPORATE ACCOUNTING

VF
Part A- essay
The figures represented in the financial statements are based on calculations and estimations.
Therefore, in such scenario fair value reposting helps the users in deriving an understanding
from the organization’s financial statements so as to make appropriate decisions. Users of
financial statements get great support from fair value reposting which further allows them to
take substantial investment related decisions. The figures projected in the financial statements
entirely depend on certain expectations that are further based on a few calculations and
estimations (Merchant, 2012). Due to such expectations considering various risks it is highly
required. Fair value determination is a three-tier process for there is a strict preference given
to measures that are related to the market.
Currently, in the era of rapid globalization and innovation, complexity arises which can be
overcome with the means of using fair value as it adds more utility to the financial
information provided in the financial statements which further helps the users in taking
appropriate decisions. There is a lot of debate going on over the utility of fair value. Some
also label fair value in the controversial box owing to the need for various other estimates by
utilizing various inputs such as management’s expectations and other projections.
Taking fair value into due consideration, a new model is being developed which carries
measurable inference on the items of the B/S. Fair value allows ascertaining the current price
of an older transaction so as to dispose of certain assets and liabilities between the parties of
industry considering the current standards. Fair value, in other words, is the price at which a
liability could be settled between the parties of the market or an asset that could be exchanged
or changed in the present market scenario (McDonough & Shakespeare, 2015).
FVA has become a subject of debate ever since the financial crisis that took place in 2008.
The value of the underlying asset majorly determines the accounting and reporting of
derivatives type of non-financial assets. It is why there are consequences faced in the market
while reporting assets and liabilities at their determined fair value owing to the distorted
financial statements. The efficiency of the market solely determines the fair value of an older
transaction (Needles & Powers, 2013). Efficient the market, passing the tests shall be easier
and vice versa. The criticism revolving around fair value measurement is minimized owing to
the introduction of new AS. FV measurement helps in evaluating the price of even such
assets and liabilities that are harder to be traded on the liquid market.
2

VF
With the revolution in IT in the recent 20 years, the significance of fair value is also
seemingly increased. Companies that earlier opted to prepare their statements on a basis other
than FV measurement are now considering it which can be seen as notes to their financial
statements. The need for fair value has also gone up due to the increasing innovations and
rapid globalization. The financial transaction over cross borders is also simple and hassle-free
as it saves a lot of time. Fair value makes a valuation of non – financial items a lot easier and
provides profound details that are required for acquiring or disposing of a financial asset. It is
very much recommended nowadays for it helps in computing the value of certain intangible
assets like goodwill. Fair value accounting has become popular and is in very much in
demand owing to its significance in AS in the rapid globalization and various innovations.
The significance of FVA in financial statements is huge owing to the globalization in the
economy (Peirson et. al, 2015). Amidst all this, it must always be remembered that FVA is a
set off between reliability and relevance related to the AS.
As per IASB/ FASB, FVA is inconsiderate of the price inefficient market conditions for the
evaluations of the transaction is amidst parties that are rational, skilled, knowledgeable, and
independent for they communicate with the motive of interrogating, providing and delivering
thorough information of the related transaction. This is because of the private details offered
by the market prices are more reliable than the details offered by the internal participants and
the items those are regularly traded on a liquid market most likely offers the best-desired
information owing to their market prices (Petersen & Plenborg, 2012). In the absence of such
information, one can take market prices of such items into consideration. It is necessary to
estimate the fair value on the basis of internal estimates and calculations when the above-
mentioned methods cannot be taken into use.
The economic view is the basis of valuation and is the key driver behind the techniques so as
to derive the fair value of a transaction. It is not always necessary that fair value
measurement encompasses the market tests in cases of all the assets and liabilities and this
becomes a matter of subjectivity. For instance, when a class of assets is purchased, it is
required for the Purchase Price Allocation to look for the difference lying amidst FVA and its
purchase price. This difference between the purchase price of an asset and its fair value needs
to be accounted as goodwill. It is absolutely true that the fair value of assets does not
necessarily pass the market test completely (YooChoi & Pae, 2017). Purchase Price
Allocation’s judgment is based on few assumptions which are rightly said in its own way and
therefore, the debate on the fair value of assets can be agreed upon to a certain extent for it is
3

VF
not always that the fair value of assets qualifies the market test to a decent extent. Also, it
should be noted that the fair value of assets is not the only and ultimate way to evaluate non-
financial assets. FVA not only recognizes non-financial assets but at the same time is an
ongoing measurement that includes judgment and estimation each and every time of reporting
(Leo, 2013).
4

VF
Part B- case study
Comparison
The annual reports of BHP Billiton and Rio Tinto have been selected for an enhanced
understanding related to reporting of fair value by these companies. In relation to the
hierarchies of fair value based on both the companies, it can be seen they have adopted
valuation method as the key strategy. Besides, when it comes to Level 1 fair value hierarchy,
both the companies have based their fair value valuation on unadjusted quoted prices in the
active markets for all the financial instruments or assets and liabilities that are identical in
nature. In relation to Level 2 hierarchy, both companies have valued the same based on inputs
that can be seen or observed for the financial assets or liabilities either indirectly or directly.
In other words, both have chosen observable market information for valuing their level 2
hierarchies. Finally, in relation to level 3, both companies have chosen valuation based on
inputs that are not observable in the market. Therefore, both have not relied upon observable
market data in relation to level 3 fair value hierarchies. Furthermore, in relation to tier assets,
it can be seen from the annual report of both companies that they have primarily focused
upon tier one assets. Moreover, primary focus on tier one assets has allowed both the
companies to diversify their affairs throughout various countries. In addition, this assists them
in facilitating low-cost options for creation of value and future growth. Besides, this also
plays a key role in implementation of culture and value together with emphasis on
productivity and safety through the deployment of technology and effective capital disciple to
attain the most value from their assets. In addition to these discussions, it can also be
observed that both the companies have chosen FVLCD method to ascertain the recoverable
amount of assets. This method stands for fair value less cost of disposal wherein the
recoverable amount of a CGU (cash generating unit) is measured based on the same and the
amount is thereafter classified based on the hierarchy of fair value for observable data of
market that is efficient with the unit of account for such CGU being examined. Overall, both
the companies believe that the best evidence of such method (FVLCD) is the value attained
from an active market.
Furthermore, in relation to classes of assets, both the companies have believed in having a
world class base of assets so that they can address the requirements of customers throughout
the world and tier one countries on a whole. Further, both the companies have depreciated
their assets like property, plant, and equipment (PPE) on a straight-line or production unit
5

VF
basis. Furthermore, in relation to trades and receivables, both the companies have identified
the same at their respective fair values and thereafter, at amortized costs through the usage of
effective interest method minus an impairment allowance. Besides, in relation to royalty
receivables in the case of Rio Tinto, the company has measured the same on an estimate of
forward sales but on the condition of royalty agreement. BHP does not have any asset like
royalty receivables when it comes to measurement of assets based on fair value.
Contrast
In relation to BHP Billiton, it can be seen that the company has tier one assets all around the
world. These assets primarily comprise of underground mines, open-cut mines, offshore gas
and oil production, onshore production, and other processing facilities. Besides, the company
has grouped these assets into different segments to offer efficient governance and enhance
performance increment (Laux, 2014). For instance, the gas and oil assets are grouped
collectively into global petroleum group of assets, etc. In contrast to this, when it comes to
Rio Tinto, even though it has focused on tier one assets as well, yet the assets are distinct
from BHP. In other words, they have assets like aluminum, diamonds, and copper.
Furthermore, Rio has not grouped its assets like that of BHP. Instead, it has framed distinct
strategies and targets for these three lines of business (Rio Tinto, 2017). For instance, for
aluminum, the company intends on offering security of supply to the smelter of product
group. The prime focus is to drive costs down to enhance the position of refineries on the
industry curve of costs (BHP Billiton, 2017). Similarly, other assets like diamonds and
copper also has their own strategies and targets and are not grouped under a head like that of
BHP. When it comes to fair value hierarchy, while Rio Tinto has primarily valued its
financial instruments like assets and derivatives, BHP on the other hand have valued its
financial assets and liabilities apart from financial instruments. For instance, based on the
valuation hierarchy of Rio Tinto, it is observable that assets like trade and other receivables,
equity shares, quoted funds, investments, come under assets whereas forward contracts,
derivatives, etc come under the purview of derivatives. In contrast to this, BHP has not only
valued its financial instruments like derivatives but has also valued financial liabilities like
non-financial liabilities and total liabilities (BHP Billiton, 2017). Therefore, this is a major
contrasting difference in the valuation hierarchy of both companies as one has not considered
current assets like cash and total liabilities while one has considered the same as well.
6

VF
Lastly, when it comes to fair value measurement of assets, when it comes to non-current
assets, Rio Tinto has primarily valued the same based on fair value less cost of disposal basis
(FVLCD) to compute the recoverable amount of the same. In contrast to this, BHP Billiton
has not only utilized the method of FVLCD to compute the recoverable amount of its non-
current assets, instead it has also utilized value in use method wherein the same is ascertained
at the current value of the expected future flows of cash anticipated to arise from the regular
utilization of the asset in their present form and its disposal. Lastly, the assets class of Rio are
world-class assets that are intended to put the company in a position of being capable of
investing in high-value growth. BHP’s assets class is focused towards diversification so that
improvement in productivity can be attained in the upcoming tenures.
7

VF
References
BHP Billiton. (2017). BHP 2017 Annual report and accounts. https://www.bhp.com/media-
and-insights/reports-and-presentations [Accessed 12 September 2018]
Leo, K. J. (2011). Company Accounting. Boston:McGraw Hill
Merchant, K. A. (2012) Making Management Accounting Research More Useful. Pacific
Accounting Review. [online]. 24(3), 1-34. Available from:
https://pdfs.semanticscholar.org/6ccf/f78a452763f17ed5e4f4ddc6b96703801403.pdf
Needles, B.E. & Powers, M. (2013) Principles of Financial Accounting. Financial
Accounting Series: Cengage Learning.
Peirson, G, Brown, R., Easton, S, Howard, P. and Pinder, S. (2015) Business Finance, 12th
ed. North Ryde: McGraw-Hill Australia.
Petersen, C. and Plenborg, T. (2012) Financial statement analysis. Harlow, England:
Financial Times/Prentice Hall.
Yoo, C.Y, Choi, T.H & Pae, J. (2017) Demand for fair value accounting: The case of the
asset revaluation boom in Korea during the global financial crisis. Journal of Business
Finance & Accounting. 45(2), 92-114. Retrieved from:
https://onlinelibrary.wiley.com/doi/abs/10.1111/jbfa.12266
McDonough,R.P & Shakespeare, C.M .(2015) Fair value measurement capabilities,
disclosure, and the perceived reliability of fair value estimates: A discussion of Bhat and
Ryan. Accounting, Organizations and Society. [online] vol. 46, 96–99. DOI:
10.1016/j.aos.2015.05.003
Rio Tinto. (2017) Rio Tinto Annual Report and accounts 2017 [online]. Available from:
http://www.riotinto.com/documents/RT_2017_Annual_Report.pdf [Accessed 12 September
2018]
8