The week in finance – Rio Tinto and IFRS

The company is only scheduled to release its full-year and half-year results for 2004 under IFRS in early May, but it is already clear that the new standards will influence the accounts significantly.

Rio Tinto has operations in Africa, Europe, the Americas, Australasia (pictured) and the Pacific rim and is exposed to fluctuations in exchange rates because of its geographic spread and the link between commodity prices and currency values.

New reporting standards will change how foreign-exchange gains on debt and derivatives are dealt with, which will have a significant impact on how the mining multinational manages the risk of foreign-exchange variations.

Because of its global positioning and vulnerability to exchange rates Rio Tinto has financed its operations through US dollar debt and implemented numerous derivative contracts.

Rio Tinto’s 2003 financial statements provide a glimpse of the massive swings IFRS can bring about.

The company had always reported exchange gains or losses from US debt through its reserves. In 2003, reporting under US GAAP, Rio Tinto could only do this if the debt qualified as a hedge of US dollar assets. All other exchange gains had to be reflected in the profit and loss account.

This saw a $1.01bn (£544m) pre-tax increase to earnings from exchange gains on US dollar debt that did not qualify for hedge accounting. After tax and minorities the addition to earnings was $623m.

The group reports under IFRS for the first time when it releases its interim results and will have to deal with exchange gains from US dollar debt in the same manner.

Changes to how derivatives are reported will also have an effect on Rio Tinto’s earnings. The company is party to a number of derivative contracts linked to future transactions to protect itself from changes in the US dollar exchange rate.

Under UK GAAP these contracts were accounted for as hedges and deferred until the transaction took place. Under IFRS, some derivative contracts will not qualify as they do not meet certain criteria.

These contracts will not be deferred, which will affect the profit and loss account before the transaction is acknowledged.

In 2003, the group had to make this change under US GAAP and recorded unrealised pre-tax gains of $182m. After tax and minorities the increase in earnings was $115m.

Company report

Medical company’s year-end report shows the complex effect of the new standards.

Smith & Nephew has noted that IFRS would take 1.5% off the company’s earnings per share figure, reducing from 21.14p to 20.81p. The company reported results for the year ending 31 December 2004 and revealed that UK earnings before goodwill and amortisation stood at £197.7m.

Under IFRS, that sum was slightly reduced to £194.6m. The biggest reduction came as a result of accounting for share-based payments under IFRS which took £5.7m off the bottom line. This was largely neutralised, however, by a £3.6m benefit because of the way in which pension costs were accounted for.

Changes to accounting for tax under IFRS would give the company an extra £1.2m on the P&L. Though sales increased 11.5% for Smith & Nephew to £1.2bn, the company noted that accounting for the year under IFRS would increase net debt. The figure would increase to £121.4m from £112m under UK GAAP.

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