Rio Tinto plc – half year report – 30 June 2019
Changes in accounting policies
This note explains the impact of the adoption of IFRS 16 ‘Leases’ and IFRIC 23 ‘Uncertainty over Income Tax Treatments’ on the Group’s financial statements and also discloses the new accounting policies applied from 1 January 2019, where these differ from those applied in prior periods. Prior period accounting policies are disclosed in note 1 to the 2018 Annual Report. The adoption of other minor changes to IFRS applicable to 2019 did not have a significant impact on the Group’s financial statements.
The impact on Equity attributable to owners of Rio Tinto as at 1 January 2019 from the adoption of IFRS 16 and IFRIC 23 is as follows:
IFRS 16 ‘Leases’ – Accounting policy applied from 1 January 2019
IFRS 16 ‘Leases’ applies to the recognition, measurement, presentation and disclosure of leases. Certain leases are exempt from the standard, including leases to explore for or use minerals, oil, natural gas and similar non-regenerative resources. The Group does not apply IFRS 16 to arrangements which fall within the scope of IAS 38 ‘Intangible Assets’.
A significant proportion by value of the Group’s lease arrangements relate to dry bulk vessels and offices. Other leases include land and non-mining rights, warehouses, equipment and vehicles. The majority of lease terms are negotiated through the Group’s procurement function, although agreements contain a wide range of different terms and conditions.
The Group recognises all lease liabilities and corresponding right of use assets, with the exception of short-term (12 months or fewer) and low value leases, on the balance sheet. Lease liabilities are recorded at the present value of: fixed payments; variable lease payments that depend on an index or rate; amounts payable under residual value guarantees; and extension options expected to be exercised. Where a lease contains an extension option which the Group can exercise without negotiation, lease payments for the extension period are included in the liability if the Group is reasonably certain that it will exercise the option. Variable lease payments not dependent on an index or rate are excluded from the calculation of lease liabilities. Payments are discounted at the incremental borrowing rate of the lessee, unless the interest rate implicit in the lease can be readily determined. For lease agreements relating to vessels and properties, non-lease components are excluded from the projection of future lease payments and recorded separately within operating costs on a straight-line basis. The right of use asset, resulting from a lease arrangement, at initial recognition reflects the lease liability, initial direct costs and any lease payments made before the commencement date of the lease less any lease incentives and, where applicable, provision for dismantling and restoration.
The Group recognises depreciation of right of use assets and interest on lease liabilities in the income statement over the lease term. Repayments of lease liabilities are separated into a principal portion (presented within financing activities) and interest portion (which the Group presents in operating activities) in the cash flow statement. Payments made before the commencement date are included within financing activities unless they in substance represent investing cash flows, for example where pre-commencement cash flows are significant relative to aggregate cash flows of the leasing arrangement.
Right of use assets are included in the review for impairment of property, plant and equipment and intangible assets with finite lives, if there is an indication that the carrying amount of the cash generating unit may not be recoverable.
Impact of transition to IFRS 16 ‘Leases’
The Group implemented the standard as at 1 January 2019. For contracts in place at this date, the Group continued to apply its existing definition of leases under the previous standards, IAS 17 ‘Leases’ and IFRIC 4 ‘Determining Whether an Arrangement Contains a Lease’ (‘grandfathering’), instead of reassessing whether existing contracts were or contained a lease at the date of application of the new standard.
For transition, as permitted by IFRS 16, the Group applied the modified retrospective approach to existing operating leases which are capitalised under the new standard (i.e. retrospectively, with the cumulative effect recognised at the date of initial application as an adjustment to the opening balance of retained earnings with no restatement of comparative information in the financial statements). For existing finance leases, the carrying amounts before transition represented the 31 December 2018 values assigned to the right of use asset and lease liability.
The Group made the following additional choices, as permitted by IFRS 16, for existing operating leases:
• not to bring leases with12 months or fewer remaining to run as at 1 January 2019 (including reasonably certain options to extend) on balance sheet. Costs for these items will continue to be expensed directly to the income statement.
• for all leases, the lease liability was measured at 1 January 2019 as the present value of any future lease payments discounted using the appropriate incremental borrowing rate. The carrying value of the right of use asset for property, vessels and certain other leases was generally measured as if the lease had been in place since commencement date. For all other leases the right of use asset was measured as equal to the lease liability and adjusted for any accruals or prepayments already on the balance sheet. The Group also excluded any initial direct costs (e.g. legal fees) from the measurement of the right of use assets at transition.
• an impairment review was required on right of use assets at initial application of the standard. The Group elected to rely on its onerous lease assessments under IAS 37 ‘Provisions, Contingent Liabilities and Contingent Assets’, as at 31 December 2018 as permitted by IFRS 16. Any existing onerous lease provisions were adjusted against the right of use asset carrying value upon transition.
• to apply the use of hindsight when reviewing the lease arrangements for determination of the measurement or term of the lease under the retrospective option.
• to separate non-lease components from lease components for vessels and properties for the first time as part of the transition adjustment.
• in some cases, to apply a single discount rate to a portfolio of leases with reasonably similar characteristics.
The impact of transition to IFRS 16 on the Group’s 1 January 2019 balance sheet is an increase in lease liabilities (debt) of US$1,248 million, an increase in right of use assets/net investments in leases of US$1,067 million, net adjustments to other assets and liabilities of US$110 million, and a charge of US$69 million to retained earnings.
The weighted average incremental borrowing rate applied to the Group’s lease liabilities recognised on the balance sheet at 1 January 2019 is 4.7%.
The most significant differences between the Group’s undiscounted non-cancellable operating lease commitments of US$1,717 million at 31 December 2018 and lease liabilities upon transition of US$1,292 million are set out below:
The Group’s activities as a lessor are not material and hence there is not a significant impact on the financial statements on adoption of IFRS 16. As the Group has some property sub lease arrangements, these were reassessed for classification purposes as operating or finance leases at transition.
The following amounts were recorded in the condensed interim financial statements for the six months ended 30 June 2019:
The Group has implemented a lease accounting system which is used for the majority of the Group’s leases. A separate contract-linked system is in use for the Group’s shipping leases.
Contracts signed, or amended, after 1 January 2019 are assessed against the lease identification criteria under IFRS 16. This may increase or decrease the number of contracts which are deemed to be leases compared with assessments of similar arrangements under IAS 17. Practical application of IFRS 16 continues to develop and the Group continues to monitor this.
EBITDA, as disclosed in the Financial Information by Business Unit on page 11 increased as the operating lease cost previously charged against EBITDA under IAS 17 has been replaced under IFRS 16 with charges for depreciation and interest which are excluded from EBITDA (although included in earnings). Short-term, low value and variable leasing costs and non-lease components associated with vessels and property continue to be charged against EBITDA.
Operating cash flows increased under IFRS 16 as the element of cash paid attributable to the repayment of principal is included in financing cash flow. The net increase/decrease in cash and cash equivalents remains unchanged.