RELATED PARTY DISCLOSURE: A case analysis BHP Billiton Ltd

Author: Iloka Benneth Chiemelie
Published: 27th March 2017

   Introduction

In the SAS No.45, Related Parties, (AICPA, Professional Standards, vol. 1, AU sec. 334), provision were made for guidelines on what should be considered in terms of determining a related party when conducting an audit of a company’s financial statement. The main objective of this standard is to provide auditors with necessary help when it comes to identifying related part and disclosures that are linked to related party transactions. It is also important that the auditor draft plans for performing and extended audit procedures in cases where there are unusual related party procedures, or indications of material misstatement in relation to the financial statements exist as a result of related party transactions (American Institute of Certified Public Accountants, 2011).

Generally, related party transactions are used to reference transactions with an unusually high benefit for the parties in transaction. Thus, it is not expected that an audit would be able to provide assurance that all related parties in the transactions have been vividly identified. However, the AU Sec. 334 did list a number of transactions that can exhibit related party transactions due to their nature (American Institute of Certified Public Accountants, 2011). They include:

·         Borrowing or lending made on interest-free basis or that have interest rates that are significantly lower or higher than what is acceptable in the market during the course of such transaction.

·         Selling assets at rates that are significantly different from its appraised value.

·         Exchange of property for a similar property in non-monetary transactions.

·         Offering loans with no scheduled terms in relation to how or when repayment will be effected (American Institute of Certified Public Accountants, 2011).

Additionally, the Practice Alert No. 95-3, of the Auditing Related Parties and Related Party Transactions did make inclusion of the following examples of events that can be used as indicators of transactions that contain undisclosed related parties as:

·         Non-substance based sales, which include funding other parties in the transaction in order to ensure that the sales price if remitted fully.

·         Commitment-based sales that include repurchase which would preclude recognition of all or parts of the revenue in situation where it is known.

·         Loans that accrue interests that are above the market rates.

·         Giving loans to parties that don’t possess the necessary abilities required for repayment.

·         Advancing company funds that are made transferable to debtors, and utilized for repayment in cases that would normally be an uncollectible loan or receivables.

·         Services or goods that are purchases from a party that have little or no cost to the company making such purchases.

·         Loans that were advanced ostensibly for a given business reason but later written off as an uncollectible.

·         Payment or services that were never rendered but has an inflated price.

·         Sales made at below market price to a middle man that in turn sales to the main related customers (ultimately in principals) and retaining the differences.

·         Purchasing assets on values that are far beyond a fair market price (American Institute of Certified Public Accountants, 2011).  

In line with the above understanding, this paper will seek to analyse the 2015 financial statements of BHP Billiton Ltd, highlighting transactions that can be considered as related parties, and discussing the importance of auditing related part transactions with the aid of relevant theories.

 Analysis of related party transactions at BHP Billiton Ltd

Figure 1: Related party transactions at BHP Billiton Ltd

Source as adapted from: at BHP Billiton Ltd (2016)

·         Sales of goods and services - in terms of joint operations, there was a significant decrease in related party transactions with 2015 experiencing US$ 198.341 as compared with US$ 252.911 recorded in 2014. However, transactions with associated increased from $3.781 million in 2014, to $6.666 in 2015 (BHP Billiton Ltd, 2016). The implication is that while the company is reducing its transactions with joint operations, it is shifting these related party transactions to the associates by selling their products at a cheaper price (potentially below market value).

·         Purchase of goods / services – although BHP Billiton Ltd sold their products at a significantly higher price to their associates, figures raised shows that they purchased at a lower price from associates. This could void earlier understanding that there is a shift in value from the company to associates. However, it could also be a form of repayment from the previous year transactions.

·         Interest income vs interest expenses – for all variables recorded, the interest income decreased in 2015 as against 2014 record, while interest expense increased in the same year as against the previous year’s records. Thus, while the company is spending more, it is gaining less. This is a significant indicator of high related party transaction geared towards shifting earnings to third party.

·         Dividends received – for joint venture, the dividend received increased, while it decreased for associated when comparing between records of 2015 and that of 2014. The change is significantly high as can be seen in the figure (1) above. Thus, this validates early claims of the company shifting its earnings through associated in the sales of good and service above.

·         Net repayment received / loans made to related parties - this increased from $6.183 million in 2014 to $69.198 million in 2015 for joint operations, with joint ventures witnessing an increase from $0.115 million in 2014 to $150.101 million in 2015 (BHP Billiton Ltd, 2016). Finally, repayments from associates decreased from $121.173 million in 2014 to $30.899 million in 2015 (BHP Billiton Ltd, 2016). At this point, earlier claims have been validated and questions could start to emerge as to why the company would be issuing more significant loans to associates even when they are not repaying as should. Thus, this is a clear case of related party transaction geared.

Importance of related party disclosure to investors

From the above analysis, a number of related party disclosures have been identified and analysed in terms of how these disclosures related to part investments and potential future ones. This is very important to the investors for a number of reasons as discussed below.

1.      It allows them to know investments that the company plans to make in the future (BHP Billiton Ltd, 2016) – from the analysis presented above, it can be deduced that BHP Billiton Ltd will likely continue to push “unworthy” funds to their associates by selling cheaper to them, buying higher from them, and issuing more loans even when the previous ones have not been repaid. This could potential hamper their business process and expansion in the future and it is something it investors would be looking into.

2.      It will allow investors to analyse fraud related transactions (BHP Billiton Ltd, 2016) - similar with previous case, related party transactions will allow investor to analyse chances of potential fraud that could be going on in the company by determining the level of fund transfer between the company and their related parties.

3.      It allows for detailed decision making (BHP Billiton Ltd, 2016)– through proper analysis, investors will be able to determine if related party transactions in BHP Billiton Ltd are significant and potential impacts they can have on returns. Thus, it will enhance their decision making process and help them reach a more concise decision as to whether or not they should invest in the company.

 Costs and benefit of disclosing related party transactions

It is easily understandable that there are advantages and disadvantages of disclosing related party transactions. Obvious advantages include that it would allow the company to be more transparent and it will enhance their overall reputations; while the obvious disadvantages could be that it will deter potential investors due to impacts that such transactions can have on their overall earnings. In any case, these pros and cons are discussed in details with the aid of shareholder theory and positive accounting theory below.

 Stakeholder theory

Stakeholders’ theory has been future in numerous academic dialogues in management and other disciplines like healthcare, public policy and law (Freeman et al., 2010). Majority of the attentions have been given to fundamental settings that represent present norms in literatures – as stakeholders are an important feature of the firms and they should be given proactive attention (Freeman et al., 2010), that stakeholders theory provides the right link between business strategy and ethics (Phillips, 2003), and that corporations who thoroughly pursue the interest of the wide group of stakeholders will be creating higher value in the course of time (Campbell, 1997; Freeman, 1984; Freeman et al., 2010). In any case, there are numerous interpretation of stakeholders’ idea and this has made development of theory difficult (Scherer and Patzer, 2011).

Notwithstanding these increased interest on stakeholders theory, only few literatures have been devoted towards understanding what it actually mean. The reason or this could be that literatures assume stakeholders’ theory is easily understandable. For instance, majority of the debates in this area has focused on the issue of who has legitimacy and the entity (or entities) that managers are responsible to (e.g., Donaldson and Preston, 1995; Freeman, 1984; Goodpaster and O'Halloran, 1994; Mitchell et al., 1997). The stakeholders’ theory is based on the understanding that although economic returns are important to the major shareholders, stakeholders want other things as well (e.g. Berman et al., 1999; Choi and Wang, 2009; Hillman and Keim, 2001; Preston and Sapienza, 1990) and the ability of a firm to address these other needs is critical for the sustainable performance of such firm (Bosse et al., 2009).

The stakeholders’ theory focuses on the need for corporations to consider value from the stakeholders’ point of view. That is to say that, instead of focusing primarily on economic gains for the shareholders, there is a need for the company to look into the people that help bring about these gains (the customers that buy the product, communities that support their operations, staffs that manufacture and sale the products etc.) and such will help bring about sustainable business performance on the long-run (Kaplan and Norton, 1992; Sachs and Riihli, 2011).

From the above discussions, disclosing related party transactions is vital for the sustainable business performance of the company. This is because, instead of non-disclosure in order to enhance opportunities of attracting new investors, disclosure would help build the company’s image especially in cases where such transactions reflect the interest of the stakeholders (e.g., cheaper supplies made for construction of public amenities). Additionally, it build strong public interest from the public due to the high level of transparency such disclosures bring to the company and would eventually help in attracting new investors into the company (as these investors would seek public interest as a potential source of growth for the company).

 Positive accounting Theory

The initial era of Positive Account Theory (PAT) dates back to the 1960s. It began with analysing some underlying guidelines used in normative accounting assumptions. The first set of theories developed during that period present detailed analysis of the relationship between accounting profits and stock prices. From the results, it was discovered that the amount of benefit obtainable does depend on the criteria used to evaluate such stock (for instance, cash flow and associated risks). In accordance with Watts and Zimmerman (1986), this is an issue and it did weaken the normative accounting literature by making accounting earnings meaningless as a result of the fact that amounts are determined on the bases of multiple valuations. The second set of studies attempted to establish differences between competing hypotheses: mechanical theory and non-impact hypothesis. Findings were mixed and made it impossible to distinguish between these theories. However, a basic discovery was made and it is that the amount of profit obtained is meaningless as it was not prepared in line with base unit; with a potential of the stock marketing being misleading as a result of manipulations made in the value of profit obtained through accounting choices.

In the context base of information, analysis did reveal that such figure are unlikely as the descriptive assumptions made are very difficult to obtain in the real world. In the efficient market hypothesis, it is noted that there is a growing competition for information (Ahmed and Duellman, 2007). Additionally, alternative sources of information about the company abounds, which include information published by the management ad interview analysts conduct with staffs. Relationships were observed between unexpected revenue and abnormal returns, which indicate that the amount of profit obtainable is a reflection of the criterion for assessment of stock although units utilized were unique. Additionally, the efficient marketing hypothesis and capital asset pricing model had a relationship which shows that impossible for the market and accounting changes to be misleading at the same time. Considerations made by the markets relates to inefficient and ineffective accounting changes in the cash flow, which makes it seem unlikely that the mechanical theory can be adopted as a description of the real world.

Essentially, the underlying theme presented by PAT is that accounting positive counting practice is such that nothing about the real wold is hiding in the account statements. This is because it would help the auditor as well as other analysts to easily figure out the causes of financial related issues faced by the company (Ali and Hwang, 2000). Thus, related party disclosure is considered a norm and a need in the account statements. In line with this understanding, it can be stated that related party disclosure as made by BHP Billiton Ltd is important for the investors. This is because it allows them to relate such accounting measures with the real world, analyse findings and determine whether past benefits are easily obtainable from present and future investments. Additionally, it allows the company to faces issues right on the spot by linking exiting accounting figure with obtainable real values as against making projections that are generally unobtainable. Thus, it can be stated that the decision to adopt related party disclosure in BHP Billiton Ltd is in-line with existing views that such will allow the company to analyse its performance the real world setting while giving the investors needed opportunity to visualize future performance from presently obtainable values.

  Conclusion

A number of discoveries have been made in relation to related party disclosure with a general finding being that such accounting practices does effect positive returns on the company. This is because it makes the auditing process transparent, increasing the company’s image and effecting higher interest from investors in the process. Although the disclosure has been attributed with positive outcome, it is imperative to acknowledge that related party transactions can be big source of fraudulent accounting practices – such as companies using such medium to divert earnings, reducing taxable accounts and shareholders’ returns in the process. Thus, as a practice, it should be carefully regulated in order to limit the extent as which it could be used for fraudulent activities. However, it is concluded that related party transaction disclosures does usher in positive impacts on the company’s overall performance due to higher stakeholders’ value and positive accounting outcomes.

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