NEED TO KNOW. IFRS 11 Joint Arrangements

Transcription

1 NEED TO KNOW IFRS 11 Joint Arrangements

2 2 IFRS 11 Joint Arrangements OVERVIEW Headlines IFRS 11 Joint Arrangements: Applies to annual periods beginning on or after 1 January 2013 Introduces the concept of joint arrangements which are classified as either joint operations or joint ventures Very narrowly defines what can be classified as a joint operation, in particular when the joint arrangement is structured using a separate legal entity Requires joint operators to account for interests in joint operations by accounting for their own (or share of) assets and liabilities Requires joint venturers to account for interests in joint ventures using the equity method Prohibits proportionate consolidation for joint ventures Is dependent upon the new definition of control introduced in IFRS 10 Consolidated Financial Statements. The creation of joint arrangements, incorporated joint ventures, unincorporated joint ventures is very common in projects that typically: Require significant funding Involve significant project risk Require collaboration among investors to share expertise and resources. For this reason joint arrangements are very common in the following industries: Extractives Property Technology Pharmaceutical. The exact nature of the joint arrangement can differ significantly dependent upon industry and geography. Incorporated joint ventures are common within the property sector, but unincorporated joint operations are the most common structure within the extractives sector. For many preparers that have interests in joint arrangements the introduction of IFRS 11 will not significantly change their current accounting treatment, but the rationale for the treatment will be determined by significantly modified principles. The first step to applying the standard, is to identify the investee s relevant activity (or activities) and then which parties have joint control over that relevant activity or activities. Relevant activities are the activities of the investee that significantly affect the investee s returns (that is, its reported profit or loss).

3 IFRS 11 Joint Arrangements 3 Potential impacts on transition to IFRS 11 Introduction of the IFRS 10 control test may mean that the investee is found to be controlled by a single party and is therefore not a joint arrangement Subtle changes to definitions may mean that two or more parties are no longer considered to have joint control and the arrangement is therefore not within the scope of IFRS 11 Previously proportionately consolidated joint ventures that are structured using a separate legal entity now typically have to be equity-accounted. For periods beginning on or after 1 January 2013, IAS 31 Interests in Joint Ventures has been superseded by IFRS 11, which prescribes the accounting for joint arrangements (classified as joint ventures, and joint operations). The treatment of joint arrangements in an entity s separate financial statements are set out in IAS 27 (2011) Separate Financial Statements. The consolidation principles previously included in IAS 27 (2008) Consolidated and Separate Financial Statements and SIC-12 Consolidation Special Purpose Entities have been combined and are now set out IFRS 10. IFRS 10 introduces a new definition of control, an understanding of which is critical for the application of IFRS 11. All applicable disclosure requirements relating to joint arrangements are now found within IFRS 12 Disclosure of Interests in Other Entities. The introduction of IFRS 11 and withdrawal of IAS 31 came about as a result of the joint International Accounting Standards Board (IASB) and US Financial Accounting Standards Board (FASB) project to reduce diversity in practice in relation to the accounting for joint arrangements, in particular: Making the substance of arrangement the key driver in how to subsequently account for an interest in another entity Removing optional alternatives for subsequent accounting of interests in joint arrangements.

4 4 IFRS 11 Joint Arrangements Change in the definition of control To understand the application of joint control, it is first essential to understand what control means as defined in IFRS 10. Under IFRS 10, control is evidenced by the existence of: An investor s power over the investee An investor s exposure, or rights, to variable returns from its involvement The ability to use its power to affect the amount of the investor s returns. To determine whether an investor has power over an investee it is essential that the investee s relevant activity (or activities) be determined. This is because relevant activities are the activities of the investee that significantly affect the investee s variable returns (that is, its reported profit or loss, or other variable returns). Consequently, for an investor to be able to affect its own share of profit or loss, or other variable returns, from the investee, the investor must be able to direct the investee s relevant activities. IFRS 10 also specifically addresses several topics that were not dealt with under the now superseded IAS 27 (2008) and SIC- 12, or deals with them differently, such as potential voting rights, de-facto control, contractual agreements with other vote holders, principal agent relationships, silos, structured entities, and franchises. A number of these topics (including potential voting rights and de-facto control), and other definitions in IFRS 10, apply to and are cross-referenced through to IFRS 11. Whether rights are substantive or merely protective in nature is a key consideration in determining whether control exists. Protective rights, such as restrictive bank loan covenants, protect the interest of the party holding those rights (in this case the bank in relation to its exposure arising from the loan) but do not give power over the entity to which the rights relate (in this case the borrower). Change in the definition of joint control IFRS 11 applies to all entities that are party to a joint arrangement, being a contractual agreement that gives two or more parties joint control over an arrangement. IFRS 11 introduces a new definition of joint control which aligns with the new control model introduced by IFRS 10. Joint control is the contractually agreed sharing of control of an arrangement, which exists only when decisions about the relevant activities require the unanimous consent of the parties sharing control (refer to section 3.2 for further details).

5 IFRS 11 Joint Arrangements 5 Specific changes from IAS 31 Under IAS 31, joint arrangements were split into three categories: Jointly controlled assets No separate entity was established, and the parties shared ownership over one or more of the assets of the arrangement. Each party subsequently accounted for its share of the assets, liabilities, expenses, and revenues on a line-by-line basis, as stipulated in the arrangement agreement Jointly controlled operations No separate entity was established, and the parties used their own assets, incurred their own liabilities and expenses, and shared the output/revenue of the arrangement. Each party subsequently accounted for its own assets, liabilities, and expenses, and its share of revenues on a line-by-line basis, as stipulated in the arrangement agreement Jointly controlled entities A separate entity was established. Each party had the choice subsequently to account for the arrangement by one of two allowed methods: 1. Equity method the interest in a jointly controlled entity was initially recorded at cost and adjusted thereafter for the post-acquisition change in the party s share of net assets of the jointly controlled entity 2. Proportionate consolidation the party s share of assets, liabilities, income and expenses of a jointly controlled entity was combined line-by-line with similar items in the party s financial statements, or reported as separate line items. In moving from IAS 31 to IFRS 11, there are a number of high level changes: The number of classifications has reduced from three to two: Jointly controlled assets and jointly controlled operations have been combined into a single classification; joint operation. The names of the classifications have changed: Jointly controlled assets and jointly controlled operations become joint operations Jointly controlled entities becomes joint ventures or, in some cases, joint operations. The structure of the entity no longer determines its classification and subsequent measurement: Under IAS 31, if a separate entity had been established, the classification was as a jointly controlled entity and the joint venture had a choice of applying either equity accounting or proportionate consolidation However under IFRS 11, other facts and circumstances must be considered before the classification is determined, thus depending on the outcome of the IFRS 11 analysis investees previously determined to be jointly controlled entities under IAS 31 will be required to be accounted for using either the equity method or the investor s interests in assets and obligations for liabilities, with no choice. Specific disclosures are required in respect of joint arrangements. This publication includes a chapter on the disclosures requirements relating to joint arrangements that are within IFRS 12 (refer to section 7 for further details). The requirements of IFRS 12 are intended to provide users of financial statements with information that assists in understanding the nature of, and risks associated with, an entity s interests in other entities (including joint arrangements). IFRS 11, together with the other consolidation standards, is effective for annual periods beginning on or after 1 January 2013, with earlier application being permitted provided that all five of the new standards are applied at the same time. The European Financial Reporting Advisory Group (EFRAG) endorsed IFRS 11 in December 2012, and it is effective in the European Union for reporting periods beginning on or after 1 January 2014, with early adoption permitted.

6 6 IFRS 11 Joint Arrangements TABLE OF CONTENTS Overview 2 1. Background the joint arrangement project Rationale for change Superseded standards and interpretations Consolidation package of standards issued by the IASB Effects analysis Effective date Scope Content of the standard Definition of a joint arrangement Joint control Introduction Joint control under IFRS 11 (the Two-Step Model ) Joint de-facto control Substantive rights in joint arrangements Protective rights in joint arrangements Joint arrangement classifications Presentation, recognition, and measurement by joint controllers Joint operators Joint venturers Other parties to a joint arrangement (i.e. non-joint controlling parties) Joint operation Joint venture Changes to IAS Venture capital organisations (or similar entities) Potential voting rights application to equity accounting Potential voting rights determining significant influence Treatment of changes in interest held Treatment of an investment in a joint venture held-for-sale Contributions of non-monetary assets to a joint venture 62

7 IFRS 11 Joint Arrangements 7 7. Disclosure requirements Significant judgements and assumptions Nature, extent and financial effects of interests in joint arrangements Commitments for joint ventures Effective date and transition requirements Application to consolidated/individual financial statements Application to separate financial statements Other points Periods prior to those beginning on or after 1 January Requirements of IAS 28 (2011) First time adopters of IFRSs Presentation of third statement of financial position Appendix A Definitions 75

8 8 IFRS 11 Joint Arrangements 1. BACKGROUND THE JOINT ARRANGEMENT PROJECT The joint arrangements project began as a research project between the International Accounting Standards Board (IASB) and the Australian Accounting Standards Board (AASB). The project was added to the IASB s active agenda in November 2004 with the aim of conducting a re-examination of the existing IAS 31 Interests in Joint Ventures. The AASBs preliminary research was centred around two major issues: The definitions of joint ventures and jointly controlled entities Accounting methods applied to such entities by investors. Subsequently the project evolved into a convergence project between the IASB and the US Financial Accounting Standards Board (FASB) with one of the aims being to reduce differences between IFRS and US GAAP. The initial exposure draft was eventually issued in September In May 2011 the International Accounting Standard Board (IASB) issued IFRS 11 Joint Arrangements, which superseded IAS 31 and SIC-13 Jointly Controlled Entities Non-Monetary Contributions by Venturers. IFRS 11 establishes principles for financial reporting by parties to a joint arrangement. It addresses two weaknesses of IAS 31: The structure of the arrangement was the only determinant of the subsequent accounting treatment of the arrangement An entity had a choice of accounting treatment for interests in jointly controlled entities (equity accounting or proportionate consolidation). This meant that economically similar arrangements could be accounted for in different ways, while economically dissimilar arrangements could be accounted for in the same way. A binding contractual arrangement that results in two or more of parties having joint control over the investee s relevant activities (refer section 3.2.) gives rise to a joint arrangement, and this is subsequently classified into one of two classifications, being either: A joint operation A joint venture. A joint operation is a joint arrangement whereby the joint controlling parties ( joint operators ) have rights to the assets, and obligations for the liabilities, relating to the arrangement. A joint venture is a joint arrangement whereby joint controlling parties ( joint venturers ) have rights to the net assets of the arrangement. In terms of joint arrangements structured through a separate vehicle (e.g. an incorporated entity), under IFRS 11 the legal structure of the arrangement is not a deciding factor in determining the classification of the arrangement. Instead, the rights and obligations specified in the joint arrangement agreement must be analysed to determine whether the parties with joint control have either: Rights to the assets, and obligations for the liabilities, or Rights to the net assets. This is in contrast to IAS 31 in which the default classification for all joint arrangements structured through a separate vehicle was jointly controlled entities. Therefore on transition to IFRS 11, it is possible that some jointly controlled entities previously recognised under IAS 31 may not retain the corresponding classification under IFRS 11 (i.e. joint ventures). This difference between IAS 31 and IFRS 11 is important as the classification of joint arrangements ultimately determines their subsequent measurement. The disclosure requirements for joint arrangements have been incorporated into a separate stand-alone standard, IFRS 12 Disclosure of Interests in Other Entities.

9 IFRS 11 Joint Arrangements Rationale for change The project to replace the existing guidance in respect of joint arrangements was undertaken for the following reasons: Under IAS 31, the accounting treatment for joint arrangements was primarily dependent on the structure or legal form of the arrangement, rather than the substance of the arrangement. Because this treatment was rules-based, rather than principles-based, the treatment of joint arrangements under IAS 31 was open to potential abuse through structuring arrangements. Under IAS 31, investors in jointly controlled entities were given a choice between two subsequent accounting treatments: Equity accounting Proportionate consolidation. This meant that financial statements for economically identical entities could be significantly different Superseded standards and interpretations Guidance for reporting periods beginning before 1 January 2013 is found in IAS 31 and SIC-13. (i) IAS 31 Interests in Joint Ventures IAS 31 requires that contractual arrangements between two or more parties where the economic activity require the unanimous consent of the parties sharing control, are to be accounted for as a joint venture. Control had the same definition as in the now superseded version of IAS 27 (2008) Consolidated and Separate Financial Statements, being power to govern the financial and operating policies of an entity so as to obtain benefits from its activities. IAS 31 establishes three classifications of a joint venture, which determines the subsequent accounting treatment. Under IAS 31, it is the legal form of the joint arrangement, rather than the substance of the arrangement, that determines the classification and subsequent accounting treatment: Any joint arrangement where a separate entity is established (i.e. a corporation, partnership, or other entity) is classified as a jointly controlled entity. Subsequently, each party then chooses to apply either: Equity accounting Proportionate consolidation. Any other joint arrangement is classified as either a jointly controlled operation or a jointly controlled asset. Subsequently, each party simply recognises its share of assets, liabilities, expenses and revenues on a line-by-line basis. (ii) SIC-13 Jointly Controlled Entities Non-Monetary Contributions by Venturers SIC-13 deals with a venturer s accounting for non-monetary contributions to a jointly controlled entity in exchange for an equity interest in the jointly controlled entity that is accounted for using either the equity method or proportionate consolidation.

10 10 IFRS 11 Joint Arrangements 1.3. Consolidation package of standards issued by the IASB In May 2011 the International Accounting Standards Board (IASB) published a package of five new/amended standards which set out new requirements for consolidation, joint arrangements and disclosure of interests in other entities. The new standards released in this package were: IFRS 10 Consolidated Financial Statements IFRS 11 Joint Arrangements IFRS 12 Disclosure of Interests in Other Entities. In addition, the following standards were amended (and renamed): IAS 27 (2011) Separate Financial Statements IAS 28 (2011) Investments in Associates and Joint Ventures. The consolidation principles previously included within IAS 27 (2008) and SIC-12 Consolidation Special Purpose Entities have been removed and incorporated to some degree within IFRS 10. The amended IAS 27 (2011) now only includes guidance for separate financial statements. Guidance for jointly controlled entities that was previously included in IAS 31 is now provided in IFRS 11. In addition all disclosure requirements, that under the old guidance were included in the individual standards (i.e. IAS 27 (2008), IAS 28 (2008) and IAS 31), are now provided in IFRS 12. Because the joint venture classification of joint arrangements is only accounted for under the equity method, the title and applicable paragraphs of IAS 28 (2011) have been amended to reflect and clarify this. IAS 31 Interests in Joint Ventures IFRS 11 Joint Arrangements SIC-13 Jointly Controlled Entities Non- Monetary Contributions by Venturers IFRS 12 Disclosure Interests in Other Entities IAS 28 (2008) Investments in Associates IAS 28 (2011) Investments in Associates and Joint Ventures Figure 1: Restructuring the standards applicable to interest in joint arrangements

11 IFRS 11 Joint Arrangements Effects analysis (a) Industries likely to be impacted There are a wide variety of industries where joint arrangements are common, either through strategic alliances, or having separate vehicles: Business services Software Wholesale trade durable and non-durable goods Investment and commodity firms Electronics Telecommunications Extractives mining, oil & gas Real estate.

12 12 IFRS 11 Joint Arrangements (b) Key changes between IAS 31 and IFRS 11 In summary, the introduction of IFRS 11 brings in several key changes, which are outlined in the table below: Key Change IAS 31 IFRS 11 Number and name of classification Under IFRS 11: Classifications reduced from three to two Jointly controlled entities are now termed joint ventures Jointly controlled operations and jointly controlled assets are now termed joint operations. Classification determination No longer determined solely by structure or legal form. Subsequent accounting Equity accounting is now the only accounting method for entities classified as joint ventures. Proportionate consolidation prohibited for entities that meet the definition of a joint venture. Definition of joint control There is a new definition of control introduced under IFRS 10, which directly impacts the definition of joint control under IFRS 11. It is essential that the relevant activity (or activities) of the joint arrangement are identified so that it can be determined who controls the relevant activity. 1. Jointly controlled entity 2. Jointly controlled operation 3. Jointly controlled asset. In all instances where a separate entity is established, these joint arrangements are classified as jointly controlled entities. Jointly controlled entities can subsequently be accounted for by either: Equity method Proportionate consolidation. Control is the power to govern the financial and operating policies of an economic activity so as to obtain benefits from it. 1. Joint venture 2. Joint operation. The establishment of a separate entity does not on its own determine the classification of a joint arrangement. The equity method is the only method for the subsequent accounting for joint ventures. An investor controls an investee when 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. Figure 2: Key changes between IAS 31 and IFRS 11

13 IFRS 11 Joint Arrangements 13 (c) Impacts of a change in classification when applying IFRS 11 The biggest impact will be for entities with investees previously accounted for in accordance with IAS 31 that: Fail the definition of joint control as derived from the new definition of control in IFRS 10 Must move from an equity-accounted jointly controlled entity under IAS 31 to a joint operation under IFRS 11 (line-by-line share of assets, liabilities, expenses, and revenues), or Currently use proportionate consolidation for a jointly controlled entity under IAS 31 that is required to be equityaccounted for as it is classified as a joint venture under IFRS 11. Some investors may also find that they have some investees which were not previously accounted for in accordance with IAS 31 (because they were determined not to be joint ventures) that do meet the definition of a joint arrangement in accordance with IFRS 11. The table below summarises the likely recognition and measurement impact entities will face based on the classification of their joint arrangements under IAS 31 and subsequent classification under IFRS 11: IAS 31 (Classification) Joint Operation IFRS 11 (Classification) Joint Venture Jointly controlled asset Jointly controlled operation Jointly controlled entity (Equity accounting) Jointly controlled entity (Proportionate consolidation) Typically no change to the accounting approach, as investors will previously have recognised their (share of) assets, liabilities, revenue, and expenses subject to the arrangement. Equity accounting will need to be discontinued. Will require an adjustment as at the beginning of the immediately preceding period, and a change in subsequent measurement from that point on. Refer to section 8 for further details. No change to the accounting approach. Entity will still be recognising its share [proportion] of assets, liabilities, expenses, and revenue. There should be no joint venture classification for these arrangements as they do not involve a separate legal entity. No change to the accounting approach. Proportionate consolidation is not available under IFRS 11. Will require an adjustment as at the beginning of the immediately preceding period, and a change in subsequent measurement from that point on. Refer to section 8 for further details. Figure 3: Impact of moving from IAS 31 to IFRS 11

14 14 IFRS 11 Joint Arrangements The key to applying IFRS 11 is the correct application of the definition of control, particularly in understanding the concept of relative rights and whether the rights attributable to an investor are substantive or protective. Example 1 Two investors, A and B, subscribe to invest in company Z, a producing mine. Each party owns 50% of the issued share capital of Z and appoint 2 members each to the board of directors. All mining operations are managed by the operator, party A. The terms of the operating agreement state that the operator can only be replaced by the unanimous consent of the investors. The operating agreement also states that unanimous approval is required for: Cessation of mining Any disposal of the mine The acquisition of any capital equipment above CU X million. The relevant activity of the arrangement is the rate at which mining activities are carried out, as the amount of ore extracted in a given period will affect the amount of profit or loss generated by company Z. Assessment From the above analysis, it would appear that the relevant activity is controlled solely by A in its capacity as the operator (which A cannot be removed from unless it unanimously decides to do so with B). As a result, A would be required to consolidate Company Z under IFRS 10. Point to note: Blocking stakes, like those held by B, do not automatically give joint control.

15 IFRS 11 Joint Arrangements 15 Example 2 Three investors, A, B and C, invest in company Z. Ownership interests are 50%, 25%, and 25% respectively. All operating decisions require a 75% majority. Assessment In this example control can be achieved by A voting with B or A voting with C. Due to its 50% voting interest A has a key blocking vote, however A neither: Controls Z outright, nor Jointly controls Z unanimously with only one other party (because decisions could be taken by A in conjunction with either B or C). Thus, this arrangement is outside the scope of IFRS 11 as joint control does not exist. Instead, each investor would determine whether it has significant influence over Z, and if so would apply the requirements of IAS 28 (2011). Note: IAS 28 (2011) paragraph 5 states that significant influence is presumed to exist if an entity directly or indirectly holds 20% or more of an entity s voting power, unless it can be clearly demonstrated this is not the case. Therefore, assuming the presumption of significant influence is not rebutted, all the investors in the above example would account for their interest in Z as an associate (i.e. they would equity account their investments). Example 3 Three investors, A, B, and C farm-in to an oil field (Z), Ownership interests are 50%, 25%, and 25% respectively. The farm-in is achieved through contract alone, and no separate legal entity is formed. All operating decisions require a 75% majority. Assessment In this example control can be achieved by A voting with B or A voting with C. Due to its 50% voting interest A has a key blocking vote, however A neither: Controls Z outright, nor Jointly controls Z unanimously with only one other party (because decisions could be taken by A in conjunction with either B or C). Thus, this arrangement is outside the scope of IFRS 11 as joint control does not exist. Instead, each investor would record their investments in accordance with either IAS 16 Property, Plant and Equipment (for property, plant and equipment) or IFRS 6 Exploration for and Evaluation of Mineral Resources (for exploration and evaluation assets).

16 16 IFRS 11 Joint Arrangements 1.5. Effective date IFRS 11 is effective for reporting periods beginning on or after 1 January 2013, with earlier application being permitted provided that all five of the new consolidation standards are applied at the same time. EU-Endorsed IFRS In December 2011 the European Financial Reporting Advisory Group (EFRAG) requested the effective date for the consolidation standards to be deferred to 1 January 2014 to allow preparers sufficient time to implement the new standards and to align it with the effective date for the proposals for Investment Entities. However at its January 2012 meeting the IASB decided not to postpone the effective date. The consolidation package standards were endorsed for use in the EU at the end of 2012, but have an effective date of 1 January 2014 with early adoption permitted. This provides entities that report in accordance with EU-Endorsed IFRS additional time to prepare for the application of the new standards. However, the permission for early adoption allows European entities, that are Foreign Private Issuers (FPI) and prepare financial statements for their US filings in accordance with IFRS as issued by the IASB, to adopt the new standards with effect from 1 January This is necessary, as the US authorities require FPIs to prepare financial statements in accordance with IFRS as issued by the IASB. Effective date of subsequent amendments In June 2012 the IASB published Consolidated Financial Statements, Joint Arrangements and Disclosures of Interests in Other Entities: Transition Guidance Amendments to IFRS 10, IFRS 11 and IFRS 12 which clarify certain aspects when an entity transitions from the old consolidation standards to the new consolidation standards that had been previously issued in May The amendments are effective for annual periods beginning on or after 1 January 2013 with early adoption being required if the new consolidation standards are early adopted. The clarifications are included in section 8. The transition guidance amendments were endorsed for use in the EU on 4 April 2013 and are effective for annual periods beginning on or after 1 January The Transition Guidance amendments to IFRS 11 are included in the detailed discussions regarding transition in section 8.

17 IFRS 11 Joint Arrangements SCOPE IFRS 11 Joint Arrangements applies to all entities that are a party to a joint arrangement, and only those entities. Investors with investees that do not meet the definition of a joint arrangement are not permitted to apply the recognition and measurement principles of IFRS 11. IFRS 11 contains specific criteria and definitions which are applied in determining whether an arrangement is or is not a joint arrangement. The definition of a joint arrangement is discussed in further detail in section 3.1. BDO comment An arrangement requires two key factors in order to meet the definition of a joint arrangement : 1. A binding contractual agreement 2. Each party must have joint control over the relevant activities of the arrangement. The requirements of joint control have their own criteria, which are discussed in detail in this publication. In practice, entities are more likely to fail the joint arrangement definition due to joint control not being established. This may be for a number of reasons, but broadly speaking this occurs where: Unanimous agreement of specified investors regarding the investee s relevant activities is not present. This may be due to a number of factors, including (but not limited to): More than one combination of parties being capable of making decisions regarding the investee s relevant activities A dispute resolution process gives power to one party The rights of one or more parties are only protective in nature (refer to section 3.6 for further detail discussion on this point). Decisions made by the parties (unanimous or otherwise) are not in respect of the investee s relevant activities. These and other scenarios are discussed in more detail in the relevant sections of this publication.

18 18 IFRS 11 Joint Arrangements 3. CONTENT OF THE STANDARD Overall, the approach to the application of IFRS 11 Joint Arrangements is broken into two key assessments: 1. Does a joint arrangement exist? (refer to sections 3.1. and 3.2.) 2. If a joint arrangement does exist, how is the joint arrangement classified? (refer to section 3.7) This is summarised below: Assessment 1 EXISTENCE OF A JOINT ARRANGEMENT Is there a contractual arrangement that gives two or more of parties joint control of the arrangement? No Arrangement is outside the scope of IFRS 11 Yes Assessment 2 CLASSIFICATION OF THE JOINT ARRANGEMENT Determine the classification of the joint arrangement based on analysis of the parties rights and obligations arising from the arrangement (refer section 3.3) Joint Operation Joint Venture Figure 4: IFRS 11 Summary of overall approach

19 IFRS 11 Joint Arrangements Definition of a joint arrangement A joint arrangement has both the following characteristics (IFRS 11.5): The parties are bound by a contractual agreement The contractual arrangement gives two or more of those parties joint control over the arrangement (refer section 3.2.). What is a contractual arrangement? While most enforceable contractual arrangements are often in writing (usually in the form of a contract or documented discussions between the parties) IFRS acknowledges that this may not always be the case (IFRS 11.B2). Therefore, determination of whether a contractual arrangement exists is based on the substance of the dealings between the parties. Specifically, IFRS 11 requires investors to consider other factors which, either on their own or in conjunction with others, result in joint control. These may include: Statutory mechanisms Terms incorporated into the investee s articles of association Other arrangements. Contractual arrangements are usually easily identifiable, as they would generally deal with such items as (IFRS 11.B4): The purpose, activity and duration of the joint arrangement How the members of the board of directors, or equivalent governing body, of the joint arrangement, are appointed The decision-making process: the matters requiring decisions from the parties, the voting rights of the parties and the required level of support for those matters. The decision-making process reflected in the contractual arrangement is key in determining whether there is joint control over the arrangement The capital or other contributions required of the parties How the parties share assets, liabilities, revenues, expenses or profit or loss relating to the joint arrangement.

20 20 IFRS 11 Joint Arrangements 3.2. Joint control Introduction Interaction with IFRS 10 IFRS 11 is based on the same control principle as IFRS 10 Consolidated Financial Statements. In comparison with previous guidance, the definition of control has fundamentally changed with the introduction of IFRS 10 (refer to section 1.3. above). The following terms are defined in Appendix A of IFRS 11 by direct reference to Appendix A of IFRS 10: Control of an investee Power Protective rights Relevant activities Significant influence. In summary the new control model requires three key elements to be present: 1. Power 2. Exposure to variable returns 3. Linkage between power & variable returns. Each of the three elements of the control model have separate components to consider in determining whether the element is satisfied under the definition (these are detailed in the figure below). Elements of Control Power Exposure to variable returns Linkage between power & variable returns Components of Power Components of Exposure to variable returns Components of Linkage between power & variable returns Existing rights Substance Principal vs. Agent Current ability to direct Potential to vary with investee s performance Relevant activities Dividends, remuneration, economies of scale etc. Substantive (not protective) Figure 5: New control model (IFRS 10) As a result, IFRS 10 and IFRS 11 cannot be viewed in isolation of each other. An understanding of the control principle and terminology of IFRS 10 is required when dealing with the requirements of IFRS 11.

21 IFRS 11 Joint Arrangements Joint control under IFRS 11 (the Two-Step Model ) Under IFRS 11, joint control: Is the contractually agreed sharing of control of an arrangement Exists only when decisions about the relevant activities of the arrangement require the unanimous consent of the parties sharing the control of the arrangement. Relevant activities are the activities of the arrangement that significantly affect returns to investors, and may include (IFRS 10.B11): i. Selling and purchasing of goods or services ii. Managing financial assets during their life (including upon default) iii. Selecting, acquiring or disposing of assets iv. Researching and developing new products or processes v. Determining a funding structure or obtaining funding. Unanimous consent means that any party with joint control can prevent any of the other parties, or a group of the parties, from making unilateral decisions (about the relevant activities) without its consent. Put simply, all parties with joint control have to agree in order for decisions relating to relevant activities to be made. This excludes protective rights (see section 3.6). Therefore, an arrangement can be a joint arrangement even when not all of its investors (or parties) have joint control of the arrangement. IFRS 11 distinguishes between parties that: Have joint control of a joint arrangement (i.e. joint operators and joint venturers) Participate in, but do not have joint control of, a joint arrangement (those parties hold a simple investment). In order to determine whether an arrangement contains parties with joint control (and is therefore a joint arrangement captured by IFRS 11), and investor adopts a two-step approach. Step 1: Firstly, an entity assesses whether all the parties, or a subset of the parties, control the arrangement (based on the control definition in IFRS 10). When all the parties, or a subset of the parties, considered collectively, are able to direct the activities that significantly affect the returns of the arrangement (i.e. the relevant activities), they control the arrangement collectively. Step 2: Secondly, an entity assesses whether it has joint control of the arrangement. Joint control exists only when decisions about the relevant activities require the unanimous consent of the parties that collectively control the arrangement.

22 22 IFRS 11 Joint Arrangements The Two-Step Joint Control Model is illustrated in the figure below: Step 1 Does the contractual arrangement give all the parties (or a group of parties) control of the arrangement collectively? No Arrangement is outside the scope of IFRS 11 Yes Step 2 Do the decisions about the relevant activities require the unanimous consent of all the parties (or group of parties) that collectively control the arrangement? No Arrangement is outside the scope of IFRS 11 Yes The arrangement is a jointly controlled arrangement within the scope of IFRS 11 Figure 6: Joint control Two-Step Model Joint de-facto control is covered in section 3.4 below. Sometimes the decision-making process that is agreed upon by the parties in their contractual arrangement implicitly leads to joint control. Example 4 Two parties establish a separate legal entity in which each has 50% of the voting rights (and equivalent power) over the investee s relevant activities. The separate legal entity s activities constitute a business (as defined in IFRS 3 Business Combinations). The contractual arrangement between the two parties specifies that at least 51% of the voting rights are required to make decisions about the separate legal entity s relevant activities. Assessment In this case, the parties have implicitly agreed that they have joint control of the separate legal entity because decisions regarding its relevant activities cannot be made without both parties agreeing. Application of the Two-Step Model shows that there is joint control, meaning that the two parties must apply the requirements of IFRS 11. Summary Two-Step Model Step 1: Yes, there is an (implicit) contractual arrangement to co-ordinate voting to achieve control. Step 2: Yes, unanimous consent is required by only a single combination of parties for decisions over the investee s relevant activities.

23 IFRS 11 Joint Arrangements 23 In other circumstances, the contractual arrangement might require a minimum proportion of the voting rights to make decisions. When a minimum required proportion of the voting rights can be achieved by more than one combination of shareholders, that arrangement is not a joint arrangement (unless, a contractual arrangement exists that specifies which parties, or combination of parties, must agree about decisions regarding the relevant activities of the investee). Example 5 Three parties establish a separate legal entity (entity Z) in which they have different shares of voting rights. Entity Z s activities constitute a business (as defined in IFRS 3). Entity A 50% Entity B 30% Entity C 20% A contractual arrangement entered into by the three parties specifies that at least 75% of the voting rights are required to make decisions about the entity Z s relevant activities. Assessment In this case, although Entity A can block any decision, it does not control entity Z alone because it always needs the agreement of B in order for decisions to be taken about entity Z s relevant activities. Under this structure, the contractual terms mean entities A and B have joint control over the entity Z. This is because the combination of A and B voting together is the only single combination of parties that can control decisions about the relevant activities of entity Z: Combination of A and B 80% Control Combination of A and C 70% No control Combination of B and C 50% No control Application of the Two-Step Model shows that there is joint control, meaning that entities A and B must apply the requirements of IFRS 11. Summary Two-Step Model Step 1: Yes, there is an (implicit) contractual arrangement to co-ordinate voting to achieve control. Step 2: Yes, unanimous consent is required by only a single combination of parties (entities A and B) for decisions over the relevant activities.

24 24 IFRS 11 Joint Arrangements Example 6 Three parties establish a separate legal entity (entity X) in which the three entities have different shares of voting rights. Entity X s activities constitute a business (as defined in IFRS 3). Entity A 50% Entity B 25% Entity C 25% A contractual arrangement entered into by the three parties specifies that at least 75% of the voting rights are required to make decisions about the relevant activities. Assessment In this case, although entity A can block any decision, it does not control the arrangement alone because it needs the agreement of either entity B or C. Entities A, B and C collectively control the arrangement; however, there is more than one combination of parties that can agree in order to reach the 75% threshold: Combination of A and B 75% Control Combination of A and C 75% Control Combination of B and C 50% No control Consequently, because there is more than one combination of parties that could control entity X (i.e. either entities A and B, or entities A and C), joint control does not exist. Therefore the combination of shareholder interests and the contractual arrangement does not give rise to a joint arrangement, and the arrangement falls outside of the scope of IFRS 11. Summary Two-Step Model Step 1: Yes, there is an (implicit) contractual arrangement to co-ordinate voting to achieve control. Step 2: No, there are multiple combinations of parties that can co-ordinate voting to achieve control. Each of the three entities needs to consider whether it has significant influence over entity X. If so, it would account for its investment as an associate in accordance with IAS 28 (2011) Investments in Associates and Joint Ventures and, if not, account for its investment as a financial asset in accordance with IAS 39 Financial Instruments: Recognition and Measurement/IFRS 9 Financial Instruments. As a variation to the above fact pattern, assume that there is also a contractual arrangement among the parties that specifies a single combination of parties which must agree in respect of decisions about entity X s relevant activities. In this case, step 2 (above) would be met and there would be joint control.

25 IFRS 11 Joint Arrangements Joint de-facto control One of the significant changes in moving from previous guidance that was set out in IAS 27 (2008) Consolidated and Separate Financial Statements to IFRS 10 is that IFRS 10 explicitly covers the principle of de-facto control. This applies in circumstances in which decisions about an investee s relevant activities are determined through shareholder votes alone, with there being no contractual or other arrangements in place that determine which party (or group of parties) has control. This is relevant to IFRS 11, because IFRS 11 includes a cross-reference to a number of the defined terms in IFRS 10, including control. Consequently, because IFRS 10 incorporates the concept of de-facto control, as well as an assessment of whether an arrangement gives rise to joint control, it is necessary to consider whether it gives rise to joint de-facto control. Under IFRS 10, de-facto control arises when an investor with less than a majority of the voting rights in another entity has control over that entity. This is when the investor has the practical ability to direct the other entity s relevant activities unilaterally (IFRS 10.B41). In determining whether an investor has de-facto control, the investor assesses the size of its own holding of voting rights relative to the size and dispersion of holdings of the other vote holders. The following key factors need to be considered: The more voting rights an investor holds, the more likely the investor is to have existing rights that give it the current ability to direct the relevant activities The more voting rights an investor holds relative to other vote holders, the more likely the investor is to have existing rights that give it the current ability to direct the relevant activities The more parties that would need to act together to outvote the investor, the more likely the investor is to have existing rights that give it the current ability to direct the relevant activities (IFRS 10.B42). Consequently, if the criteria set out below are met, it would be clear that that the investor has control and no further analysis is needed: Direction of relevant activities is determined by majority vote Investor holds significantly more voting rights than any other vote holder or organised group of vote holders Other shareholdings are widely dispersed (IFRS 10.B43/B44). IFRS 10.7 notes that an investor controls an investee if it has all of the following: Power over the investee (whether or not that power is used in practice) Exposure, or rights, to variable returns from its involvement The ability to use its power to affect the amount of the investors returns.

26 26 IFRS 11 Joint Arrangements However, it is necessary to make a careful distinction between de-facto joint control and joint de-facto control, as only joint de-facto control results in a joint arrangement within the scope of IFRS 11. The following table illustrates the difference between the two concepts: De-facto type Description Within the scope of IFRS 11? De-facto joint control Joint de-facto control There is past history of the parties voting together over the relevant activities of the arrangement, even though there is no contractual agreement to do so. Due to the remaining investors being numerous and dispersed the decisions of the parties in effect become the final decisions. Where there is a large block of voting power held by a number of investors that have a contractual agreement to always vote together in relation to the relevant activities of the investee. The remaining shares are held by many other small and dispersed independent investors. No. With no contractual agreement this situation automatically fails step 1 of the Two-Step Model. IFRS 11 requires a contractual or implicit agreement to be in place between or among parties before there is joint control. Yes. Joint de-facto control is considered under IFRS 11. Figure 7: De-facto joint control vs. joint de-facto control Example 7 Entities A and B hold interests in a separate legal entity, together with other investors (dispersed in scenarios 1 and 2, and Entity C in scenario 3). Three scenarios are set out below, in which the contractual arrangement for each specifies that at least a majority (i.e. more than 50%) of the voting rights are required to make decisions about the relevant activities. Scenario 1 Scenario 2 Scenario 3 Entity A 35% Entity A 24% Entity A 24% Entity B 35% Entity B 24% Entity B 24% Dispersed 30% Dispersed 52% Entity C 52% Additional information: Scenario 1 There is no contractual agreement between A and B to vote together. Scenario 2 There is a contractual agreement between A and B to vote together. Scenario 3 There is a contractual agreement between A and B to vote together. Entity A and B also have a substantive option to each acquire 10% of entity C s shares.

27 IFRS 11 Joint Arrangements 27 Assessment Scenario 1 In this case, as there is no contractual agreement or other implicit arrangement between A and B to vote together, there is no joint control. Entities A and B would then need to consider whether each of them has significant influence If so, the investment would be accounted for as an associate in accordance with IAS 28 (2011) and, if not, the investment would be accounted for as a financial asset in accordance with IAS 39/IFRS 9. Summary Two-Step Model Step 1: No, there is no (implicit) contractual arrangement to co-ordinate voting to achieve control. Step 2: N/A (Step 1 failed). Scenario 2 In this case, there is joint de-facto control due to: There being a contractual agreement between A and B to vote together The interaction between A and B s combined voting share, the 50% hurdle, and the remaining dispersed investors, which results in the practical ability of A and B to direct the relevant activities unilaterally. Practical ability of A and B to direct the relevant activities unilaterally In practice, the decisions that A and B take jointly will ultimately be the final decision in either of the following scenarios: At least more than 4% of the dispersed investors do not vote More than 2% of the dispersed investors vote the same way as A and B. Both of these scenarios are sufficiently likely, and would therefore result the decisions of A and B ultimately determining the decisions over the relevant activities of the arrangement. Therefore A and B are deemed to have the practical ability to direct the relevant activities unilaterally and have joint de-facto control. Summary Two-Step Model Step 1: Yes, there is an (implicit) contractual arrangement to co-ordinate voting to achieve control. Step 2: Yes, because the 48% block holding is considered to result in control, unanimous consent is required only by a single combination of parties who have a contractual agreement to vote the same way regarding decisions in relation to relevant activities. BDO comment In this scenario, where entities A and B hold a significant minority block of shares (48%), it is relatively simple to determine that joint de-facto control exists. However, as IFRS 11 (and IFRS 10) are designed as principles-based standards, the question in practice will be at which point a significant minority block of voting rights does not result in de-facto joint control. There are no bright lines, meaning that this question does not depend on whether a specified threshold is met, such as a combined total of 45%, 40%, or 35%. The assessment of joint de-facto control will therefore require careful judgement by investors, so as to ensure that they determine appropriately whether arrangements are required to be accounted for in accordance with IFRS 11. This judgement will typically require disclosure in the investor s financial statements in accordance with IAS 1 Presentation of Financial Statements paragraph 122.