IFRS 11 Joint Arrangements

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Garey Newton
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1 IFRS 11 Joint Arrangements

2 Today s agenda Background and objectives Joint arrangements Classification of a joint arrangement Accounting treatment Continuous assessment Transition Consequential amendments Disclosures Page 2

3 Background and objectives Eliminate accounting policy choice to account for jointly controlled entities using proportionate consolidation Structure is no longer the only determinant of classification Converge IFRS and US GAAP Page 3

4 Joint arrangements A joint arrangement is an arrangement over which two or more parties have joint control A joint arrangement is either a joint operation or a joint venture and has the following characteristics: The parties are bound by a contractual arrangement That contractual arrangement gives two or more of those parties joint control of the arrangement Contractual arrangement defines the terms Often, but not always, in writing Documented discussions Page 4

5 Joint arrangements Joint control Joint control is the contractually agreed sharing of control of an arrangement, which exists only when the decisions about the relevant activities require the unanimous consent of the parties sharing control Control: the investor is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee Relevant activities: the activities of the arrangement that significantly affect the investee s returns Unanimous consent: no single party controls the arrangement and two or more parties must agree to share control Page 5

6 Joint arrangements Joint control Example Two investors form an investee to develop and market a medical product One investor is responsible for developing and obtaining regulatory approval Other investor is responsible for manufacturing and marketing Determine which activity most significantly affects returns Purpose and design of the investee Factors that affect profit margin, revenue, value, etc Effect on returns from each decision-maker s authority Investors exposure to variability of returns Page 6

7 Joint arrangements Joint control Does the contractual arrangement give all the parties (or a group of the parties) control of the arrangement collectively? Yes Do the decisions about the relevant activities require the unanimous consent of all the parties that collectively control the arrangement? Yes Joint Arrangement No No Outside the scope of IFRS 11 (not a joint arrangement) Joint operation Joint venture Page 7

8 Joint arrangements Joint control - Examples Requirement Example 1 Example 2 Example 3 75% vote to direct relevant activities 75% vote to direct relevant activities Party A 50% 50% 35% Party B 30% 25% 35% Majority vote to direct relevant activities Party C 20% 25% Widely dispersed Conclusion Even though A can block any decision, A does not control B, because A needs B to agree = joint control between A and B. No control (or joint control) because multiple combinations could be used to reach agreement No control (or joint control) because multiple combinations could be used to reach agreement Page 8

9 Joint arrangements Unit of account Master agreement Manufacturing Distribution Country A: unlimited partnership joint operation Country B: limited partnership joint venture Country C: unlimited partnership joint operation Country D: limited partnership joint venture Page 9

10 Classification of a joint arrangement Legal form of the separate vehicle Does the legal form of the separate vehicle give the parties rights to the assets, and obligations for liabilities, relating to the arrangement? Yes No Contractual terms of the arrangement Do the contractual terms of the arrangement specify that the parties have rights to the assets, and obligations for the liabilities, relating to the arrangement? Yes Joint operation No Is the arrangement designed so that Other facts & circumstances The parties have rights to substantially all of the economic benefits of the JA? The JA depends on the parties on a continuous basis for settling the liabilities? Yes No Joint venture Page 10

11 Classification of a joint arrangement Legal form Legal form is no longer the sole factor, but is still very important in classifying a joint arrangement Joint Operations Parties have rights to the assets and obligations for the liabilities of the arrangement Without a separate vehicle, the joint arrangement is a joint operation Joint Ventures Parties have rights to the net assets of the arrangement To be a joint venture, there must be a separate vehicle The legal form of the separate vehicle does not confer separation between the parties and the separate vehicle (e.g., general partnership) The legal form of the separate vehicle causes it to be considered in its own right (e.g., corporation) Separate vehicle: A separately identifiable financial structure, including separate legal entities or entities recognised by statute, regardless of whether those entities have a legal personality Page 11

12 Classification of a joint arrangement Legal form - Example Fact pattern: A and B jointly establish a new corporation (C) in which each party has a 50% ownership interest The purpose of this arrangement is to manufacture the materials required by both parties for their own individual manufacturing processes Analysis: Incorporation enables the separation of C from A and B Assets and liabilities of C are the assets and liabilities of the incorporated entity Legal form of the separate vehicle indicates that the parties have rights to the net assets of the arrangement Therefore Joint Venture Page 12

13 Classification of a joint arrangement Examples of contractual terms Assets Joint Operations Share all interests in the assets in a specified proportion Hold assets of the arrangement as tenants in common in a specified proportion Have rights to all of the economic benefits generated by the assets Liabilities Share all liabilities, obligations, costs and expenses in a specified proportion Have liabilities for claims raised by third parties or to customers of the arrangement Joint Ventures Do not have interests (i.e., no rights, title, or ownership) in the assets of the arrangement Are not liable for the debts and obligations of the arrangement Liabilities to the arrangement do not exceed the parties investment in the arrangement Creditors do not have any recourse against any party in for debts or obligations Page 13

14 Classification of a joint arrangement Contractual terms - Example (Continued) Fact pattern: A and B modify the features of C through their contractual arrangement so that each has an interest in the assets of C and each is liable for the liabilities of C in a specified proportion Analysis: Legal form of the separate vehicle indicates that the parties have rights to the net assets of the arrangement However, contractual modifications to the features of C cause the arrangement to be a joint operation Page 14

15 Classification of a joint arrangement Facts and circumstances Facts and circumstances might indicate a joint operation if they result in the parties having: Rights to the assets Obligations for the liabilities Examples: Restrictions on customers Commitments to purchase all the output produced Expectations to fund losses Consider purpose and design Commitment upon default or guarantee is not determinative of being a joint operation Page 15

16 Classification of a joint arrangement Facts and circumstances - Example (Continued) Fact pattern: A and B agreed to purchase all the output produced by C in a ratio of 50:50 C cannot sell any of the output to third parties, unless this is approved by A and B (expected to be uncommon) Price of the output sold is designed to cover expenses incurred by C (intended to operate at break-even level) Analysis: Joint operation Page 16

17 Accounting treatment IAS 31 Jointly controlled operations Recognise its assets, liabilities, expenses, and its share of income Jointly controlled assets Recognise its assets, liabilities, revenue, and expenses, and/or its relative shares thereof Jointly controlled entities Equity method or proportionate consolidation Joint Ventures IFRS 11 Joint operations The parties with joint control have rights to the assets and obligations for the liabilities of the arrangement Recognise its assets, liabilities, revenue, and expenses, and/or its relative shares thereof Joint ventures The parties with joint control have rights to the net assets of the arrangement. Equity method Joint Arrangements Page 17

18 Accounting treatment Proportionate consolidation vs. joint operation When is accounting for a joint operation the same as proportionate consolidation? Equal rights to all assets all liabilities probably same Rights to a specified percentage of certain assets and differing rights (and percentages) to other assets, and different obligations for various liabilities likely to be a difference Nature of assets and liabilities might change Assets - same nature as recognised by joint operator OR (for example) reimbursement right? Liabilities - same nature as recognised by joint operator OR (for example) cash due to joint operation? Page 18

19 Accounting treatment Parties without joint control Joint operation: Account for rights to assets, and obligations for liabilities, relating to the joint operation (same as accounting by a joint operator) Or, if no rights or obligations, account for interest in joint operation according to applicable IFRS Joint venture: Financial instrument IFRS 9 Significant influence use equity method (same as joint venturer) Page 19

20 Continuous assessment Reassess if change in: Joint control Type of joint arrangement Legal form Contractual terms Facts and circumstances Page 20

21 Transition Proportionate consolidation to the equity method Effective 1 January 2013 Recognise investment in the joint venture for earliest period presented Measure investment as the aggregate of the carrying amounts of the assets and liabilities that were previously proportionately consolidated Including any goodwill arising from acquisition Investment becomes deemed cost for equity method Test the investment for impairment Disclose aggregated assets and liabilities Page 21

22 Transition Equity method to joint operation Effective 1 January 2013 Derecognise the equity method investment for earliest period presented ( A ) Recognise share of assets and liabilities, including goodwill that formed part of the carrying amount of the equity method investment ( B ) Any difference between above: If B > A, first reduce goodwill, then retained earnings If A > B, recognise in retained earnings Disclose reconciliation Page 22

23 Consequential amendments IAS 28 Investments in Associates and Joint Ventures Defines significant influence Describes the equity method of accounting Associates over which reporting has significant influence Joint ventures (as newly defined) over which an entity has joint control Incorporates SIC-13 (contribution of non-monetary asset to a JV) No remeasurement if interest changes from associate to joint venture (or vice versa) Page 23

24 Disclosures For individually material joint arrangements: Nature of the relationship with the joint arrangement Proportion of the ownership interest vs. voting shares For individually material joint ventures: Method of accounting Summarised financial information Fair value of (if quoted market price is available) Aggregate information for immaterial JVs Summarised financial information is also required if the fair value option is used Page 24

25 IFRS 11 Joint Arrangements Appendix - Examples

26 Appendix list of examples Example 1 Construction Example 2 Real estate Example 3 Manufacturing & distribution Example 4 Bank Example 5 Oil & gas Example 6 Liquefied natural gas Page 26

27 Example 1 Construction Fact pattern A and B enter into a contract to design and construct a road for a government A and B set up Z to conduct the arrangement Z enters into the contract with the government However, the legal form of Z is such that A and B have rights to the assets and liabilities for the obligations of Z based on their participation shares Profit or loss resulting from the arrangement is shared by A and B based on their participation shares A and B assign an operator, who will be an employee of either A or B, activities executed on a no gain or loss basis Page 27

28 Example 1 Construction Analysis Joint operation Separate vehicle Yes (Z) Legal form Does not confer separation between A and B and the separate vehicle (Z), because assets and liabilities in Z are A and B s assets and liabilities Terms A and B have rights to the assets, and obligations for the liabilities, relating to Z Facts & circumstances Do not need to be considered, because legal form and terms indicate joint operation Accounting A and B each recognise their share of the assets, liabilities, revenue and expenses based on their participation share in Z Page 28

29 Example 2 Real estate Fact pattern A and B (real estate companies) enter into a contract to acquire and operate a shopping centre A and B set up X to own the shopping centre Legal form of X is such that X has rights to the assets and liabilities for the obligations (not A and B) Activities include: rental of retail units, managing the car park, maintaining the centre and its equipment (such as lifts), and building the reputation and customer base The parties are not liable for the debts or liabilities of X (liability limited to unpaid capital contribution) A and B have the right to sell or pledge interests in X A and B receive share of the net rental income Page 29

30 Example 2 Real estate Analysis Joint venture Separate vehicle Yes (X) Legal form Confers separation between A and B and the separate vehicle (X); that is, the assets and liabilities in X are not A and B s assets and liabilities Terms A and B have rights to the net assets of X Facts & circumstances None that indicate that A and B have rights to substantially all the economic benefits of the assets relating to the arrangement, or obligations for the liabilities relating to the arrangement Accounting Account for interests in X using equity method Page 30

31 Example 3 Manufacturing & distribution Fact pattern A and B enter into a contract to manufacture and distribute a product in a framework agreement Manufacturing activity: Separate vehicle (M) M s legal form causes confers separation between A and B and M (assets and liabilities of M are its own) A and B committed to purchasing all of the whole production in accordance with their ownership in M A and B subsequently sell the product to another joint arrangement, established exclusively for distribution A and B do not have rights to the assets or obligations for the liabilities relating to the manufacturing activity Page 31

32 Example 3 Manufacturing & distribution Fact pattern Distribution activity: Separate vehicle (D) D s legal form causes confers separation between A and B and D (assets and liabilities of D are its own) D orders its requirements for the product from A and B according to the needs of the different markets where the distribution arrangement sells the product A and B do not have rights to the assets and obligations for the liabilities relating to the distribution activity Page 32

33 Example 3 Manufacturing & distribution Fact pattern Framework agreement also establishes: M will produce product to meet the requirements for that the distribution arrangement places on A and B; M will sell product to A and B at a price that covers all production costs incurred A and B sell the product to D at a price agreed by A and B Any cash shortages incurred by M will be financed by A and B in accordance with their ownership interests in M Page 33

34 Example 3 Manufacturing & distribution Analysis Separate vehicle Legal form Contractual terms Other facts and circumstances Manufacturing: Joint operation Yes M Yes D Confers separation between A and B and separate vehicle M Assets and liabilities in M are not A and B s assets and liabilities A and B purchase all of the production, and therefore all the economic benefits of M Exclusive dependence of M on A and B for cash flows (sale of product and funding) indicate A and B have an obligation for the liabilities of M Distribution: Joint Venture Confers separation between A and B and separate vehicle D Assets and liabilities in D are not A and B s assets and liabilities None that indicate that A and B have rights to substantially all the economic benefits of the assets relating to D, or obligations for the liabilities relating to D Page 34

35 Example 3 Manufacturing & distribution Variation Fact pattern M also distributes product to other customers M also sells product directly to the D No fixed proportion of the production of M is committed to be purchased by, or sold to, D Analysis Manufacturing: changes to joint venture M has own customers and own distribution M has inventory and credit risk M not dependent on A and B Distribution: remains joint venture Page 35

36 Example 4 Banking Fact pattern A and B agree to combine their corporate, investment banking, and asset management A and B set up Bank C C is publicly listed; A and B each hold 40% Legal form of C is such that C has rights to the assets and liabilities for the obligations (not A and B) In the event of dispute, A and B agree to provide funds to ensure C complies with the applicable legislation and banking regulations, and honours any commitments made to the banking authorities Commitment represents the assumption by A and B of 50% of any needed funds that would be required to ensure C complies with legislation and banking regulations Page 36

37 Example 4 Banking Analysis Joint venture Separate vehicle Yes (C) Legal form Confers separation between A and B and the separate vehicle (C); that is, the assets and liabilities in C are not A and B s assets and liabilities Terms A and B have rights to the net assets of C Facts & circumstances Commitment does not indicate that A and B have obligations for the liabilities relating to the arrangement Accounting Account for interests in C using equity method Page 37

38 Example 5 Oil & gas Fact pattern A and B agree to undertake oil & gas exploration, development and production activities A and B set up separate vehicle H One of the parties is appointed as operator and is responsible for managing the work programmes Rights and obligations of H are shared by A and B: Permits, rehabilitation liabilities, royalties, taxes Production of H Costs associated with work programmes Costs are covered by cash calls on A and B If A or B fails to satisfy its monetary obligations, the other party is required to contribute to C the amount in default, which then becomes a debt between A and B Page 38

39 Example 5 Oil & gas Analysis Joint operation Separate vehicle Yes (H) Legal form Confers separation between A and B and the separate vehicle (H) Terms Overrides the legal form A and B have rights to the assets of C (rights, production) A and B have obligations for the liabilities of C (costs for programmes) Facts & circumstances Do not need to be considered, because legal form and terms indicate joint operation Accounting A and B each recognise their share of the assets, liabilities, revenue and expenses based on their participation share in H Page 39

40 Example 6 Liquefied natural gas Fact pattern A and B agree to develop and operate a gas field and a liquefied natural gas (LNG) facility A and B set up separate vehicle C Daily management of the gas field and LNG facility will be undertaken by the staff of B C will reimburse B for the costs it incurs in managing C is liable for taxes, royalties and liabilities incurred A and B have an equal share in the net profits from the activities and dividends distributed by C C enters into a loan Recourse to A and B if C defaults during construction of LNG facility No recourse to A and B once the LNG facility is in production, because the cash inflows of C would be sufficient Page 40

41 Example 6 Liquefied natural gas Analysis Joint venture Separate vehicle Yes (C) Legal form Confers separation between A and B and the separate vehicle (C) Terms A and B have rights to the net assets of C Facts & circumstances A and B s guarantees of the loan does not indicate that A and B have an obligation for the liabilities of C Accounting Account for interests in C using equity method Page 41

3 This IFRS shall be applied by all entities that are a party to a joint arrangement.

3 This IFRS shall be applied by all entities that are a party to a joint arrangement. International Financial Reporting Standard 11 Joint Arrangements Objective 1 The objective of this IFRS is to establish principles for financial reporting by entities that have an interest in arrangements