Today, we’ll take a look at the investments in joint arrangements which can be either joint venture or joint operation.
These investments are covered by the standard IFRS 11 Joint Arrangements.
IFRS 11 is relatively new standard. It was issued in 2011 and it is effective for all reporting periods starting 1 January 2013 or later.
IFRS 11 replaced the older rules in IAS 31 Interests in Joint Ventures and interpretation SIC-13 Non-monetary contributions by venturers. As a result, IAS 31 and SIC-13 are no longer valid.
What is the objective of IFRS 11?
The objective of IFRS 11 Joint Arrangements is to establish principles for financial reporting by entities that have an interest in arrangements that are controlled jointly (i.e. joint arrangements).
To meet this objective, IFRS 11:
- Defines joint control;
- Requires determining the type of joint arrangement; and
- Account for the interest in a joint arrangement based on the type.
What is joint control and how to detect it?
Standard IFRS 11 defines joint control as 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.
Let’s break it down. There are 3 basic elements of joint control:
- Contractual arrangement
Please note that here, contractual arrangement must be present – often in writing in the form of contract or some documented decisions of the parties involved. Sometimes law or other statutory mechanisms are sufficient to create contractual arrangement.
- Sharing of control
This condition or element is met when all parties, or group of parties, considered collectively, are able to direct the relevant decisions of the arrangement.
In other words – no single party can decide on its own.
Let me give you an example:
Imagine 3 joint venturers: Company Large has a share of 50% in a joint venture, companies Medium and Regular have shares of 25% each. Let’s say that the contract specifies that to make important decisions, at least 75% must agree.
What does that mean?
Well, although Large can veto or block any decisions by Medium and Regular (in other words, Medium and Regular do not have enough voting power to decide against Large’s decision), Large does not have a control, because to make a decision, Large still needs the support of either Medium or Regular.
In this example, collective control is present, but you still need to assess whether Large, Medium and Regular need to decide unanimously (all of them must agree) or not. That would be written in the contract, for example.
- Unanimous consent
Unanimous consent means that every party of the joint arrangement must agree with (or at least does not object to) the decision and no one can block it.
In our above example, if the contract says it simply: 75% of voting power is enough to make all decisions, then there is NO unanimous consent, because just 2 parties are sufficient to present (Large and either Medium or Regular).
When you are assessing the presence of joint control, this chart might help:
Classify your joint arrangement
Once the investor acquires an interest in joint arrangement, then she must classify this arrangement correctly and apply the appropriate accounting method.
There are 2 types of joint arrangements:
- Joint venture
In a joint venture, the parties having joint control have rights to the net assets of the arrangement. These parties are called “joint venturers”.
- Joint operation
In a joint operation, the parties having joint control have rights to the assets and obligations for the liabilities relating to the arrangement. These parties are called “joint operators”.
How to distinguish between joint venture and joint operation
It’s very important to classify the joint arrangement correctly as the accounting method for both types is different.
The classification depends upon the rights and obligations arising from the joint arrangement.
When assessing the rights and obligations from the joint arrangements, it’s very important to look at how the joint arrangement is structured, mainly whether the arrangement is structured through separate vehicle or not.
Separate vehicle is a separately identifiable financial structure, including separate legal entities (e.g. company) or some entities recognized by a statute (not necessarily having legal personality).
NOT structured through a separate vehicle
When a joint arrangement is NOT structured through a separate vehicle, then the classification is easy: it is a clear joint operation.
Structured through a separate vehicle
When the joint arrangement is structured through separate vehicle, then it can be either joint venture or joint operation.
For making your conclusion, you should examine further:
- The legal form of joint arrangement;
- The terms of the contractual arrangement; and
- Other facts and circumstances when relevant.
Let me give you another example:
Imagine companies Medium and Regular invest their money in the separate legal entity, MRJoint. Medium and Regular have 50% share each.
Is it joint venture or joint operation?
As Medium and Regular established separate vehicle (MRJoint), it can be either joint venture or joint operation.
Now, what rights and obligations do Medium and Regular have with regard to MRJoint?
If there’s no other contractual arrangement and MRJoint is separated from its owners (meaning that assets and liabilities in MRJoint belong to MRJoint), then Medium and Regular have interests in joint venture.
However, if there is some contractual arrangement stating that both Medium and Regular have interests in the assets of MRJoint and they are liable for the liabilities of MRJoint in a specified proportion, then it would be joint operation.
My own experience is that once parties establish a separate legal entity (company) with sharing joint control, then it is a joint venture in most cases.
Accounting for joint arrangements
IFRS 11 sets two different methods of accounting for interests in joint arrangements, depending on the type of the arrangement:
Accounting for interest in joint venture
IFRS 11 requires accounting for the investment in a joint venture using the equity method according to IAS 28 Investments in Associates and Joint Ventures.
I have covered the basic principles of the equity method in the article about IAS 28. If you need more than basics and you wish to actually learn how to apply the equity method, then please consider subscribing to my premium package the IFRS Kit.
Accounting for interest in joint operation
When an investor classifies its investment as a joint operation, then you should recognize in the financial statements:
- Its assets, including its share of any assets held jointly;
- Its liabilities, including its share of any liabilities incurred jointly;
- Its revenue from the sale of its share of the output arising from the joint operation;
- Its share of the revenue from the sale of the output by the joint operation; and
- Its expenses, including its share of any expenses incurred jointly.
You need to account for these items in line with the appropriate standard, for example – you would account for a machine provided to joint operation in line with IAS 16 Property, Plant and Equipment.
Here’s the video with the short summary of IFRS 11 Joint Arrangements: