Slide 1: Lease: Exposure Draft 2013
Slide 2: BHP Billiton: Company Background
One of the largest resources company in the world
Operates in countries like USA, Australia, Pakistan, Algeria, Canada, Chile, Brazil, Thailand, Colombia, Peru & Venezuela.
One of the leading manufacturer of iron ore, copper , aluminum, uranium, nickel, silver and coal.
Also one of the major player in oil exploration and oil extraction.
Slide 3: BHP Billiton: Current Lease Accounting Practice
BHP Billiton has many different types of lease agreements in different countries.
Land lease agreements are carried in book of accounts at cost.
Depreciation of the leased property or equipment is done to their residual value over the period of its estimated life and is reassessed annually
Operating leases for property and equipment are presented in the annual report as “commitments” as per the actual terms of agreement.
Slide 4: BHP Billiton : Current Lease Accounting Practice
In case of accounting for operating leases BHP Billiton do not account for renewal options and inflation adjustments.
Operating lease assets are not capitalized and only rental payments are included in the income statement.
Provision for the assets are made only when it is determined that when the asset will no longer be profitable.
Future obligations arising out of lease agreements are not shown in the balance sheet and shown as commitment for the company in future
Slide 5: Exposure Draft: Proposed Changes
It proposes a dual model approach
Income and expenses arising out of operating lease agreements needs to be accelerated.
First lease assets needs to be classified as type A or type B based on right-of-use.
In general buildings & equipments are type A asset.
Land is considered type B asset in most of the cases.
Fleet of vehicles is mostly type A asset.
Slide 6: Exposure Draft: Proposed Changes
For Type A assets
First determine the lease related inflow and outflow.
Find the present value of the asset by discounting future cash flows.
Use the interest rate for the lessor as the discount rate.
Once the present value is determined use that as the fair value for the leased asset.
Using that fair value, treat the leased type A asset similarly like an owned asset for accounting in balance sheet.
Slide 7: Exposure Draft: Proposed Changes
For Type B Assets
First determine the lease related inflow and outflow.
In many cases to find out a fair market value is almost impossible for type B asset ( like land).
In case of fair value of the asset not found , find the present value of the asset by discounting future cash flows.
Use the interest rate for the lessor as the discount rate.
Once the present value is determined use that as the fair value for the leased asset.
Using that fair value, treat the leased type A asset similarly like an owned asset for accounting in balance sheet.
In some cases for this type of assets a constant fair market value can also be used. ( which may equal to the value at the time of commencement of the lease)
Slide 8: Exposure Draft: Proposed Changes
Off balance sheet treatment of the leases are no longer entertained in this draft.
Liability is calculated as the present value of the lease liability less any incentives received from the lessor.
Lease liability needs to be amortized based on the effective interest rate method.
Slide 9: Criticism of Exposure Draft
Why lease agreements need not accelerate its expense and earnings and not service contracts?
The draft is complex to interpret and implement.
The definition of right-of-use to determine the type of asset class is not comprehensive.
Implementation cost will be high for the companies as there are some major proposed changes.
Slide 10: How changes will affect BHP Billiton
How to identify Type of Asset
It will be easy for BHP Billiton to categorize its operating assets which are under lease agreements.
In most of the cases land agreements are with governments and for a very long term or a term till when BHP Billiton will be able to make profit out of it.
Land lease agreements can be categorized as type A.
Equipments and buildings can be categorized as type B assets as they have fair market value and the value of the assets depreciate over time.
Slide 11: How changes will affect BHP Billiton
Handling of Type A assets
Example:
BHP Billiton had a five year contract starting from 2012 for an oil tanker ship.
Already have paid the lease for the first year of $330,000.
Ship is of asset type A.
Lease payments for next four year need to be converted to present value using a discount rate.
Present value is $1,124,620 using a 6% discount rate.
Now this type A leased asset needs to be handled as a company owned asset in balance sheet.
Slide 12: Conclusion
BHP Billiton has lot of assets which are leased.
New exposure draft if implemented will affect BHP Billiton in a big way.
The draft is facing a lot of criticism from many corners so for the time being chances that proposed changes will be implement as accounting guidelines is remote.
