Accounting for the Transfer of Businesses in Joint Venture Formations

When entities contribute businesses to the formation of a joint venture, the accounting treatment can become complex and nuanced. IFRS 11 Joint Arrangements does not provide specific guidance on how to account for such transactions, leaving entities to navigate the requirements based on the principles outlined in other IFRS standards, particularly IFRS 3 Business Combinations.

Theoretical Perspective: Business Combination Accounting

From a theoretical standpoint, the key consideration in accounting for the transfer of businesses to a joint venture is whether the contributed assets and activities meet the definition of a business combination under IFRS 3. If the contributed items qualify as a business, the contributing entity must apply the acquisition method of accounting, recognizing its share of the identifiable net assets at fair value and accounting for any goodwill or gain on a bargain purchase.The IFRS Interpretations Committee has provided guidance on this matter, clarifying that the formation of a joint venture does not, in itself, constitute a business combination. However, if one of the parties to the joint venture contributes a business, as defined in IFRS 3, the contributing party must apply the acquisition method of accounting for that transaction.

Practical Considerations: Assessing the Definition of a Business

In practice, entities must carefully assess whether the contributed assets and activities meet the definition of a business under IFRS 3. This assessment involves evaluating the following key criteria:

1. Inputs: The contributed assets must include inputs, such as intellectual property, employees, or other resources, that can be applied to the creation of outputs.
2. Processes: The contributed assets must include substantive processes that, when applied to the inputs, can lead to the creation of outputs.
3. Outputs: The contributed assets and processes must be capable of producing outputs, such as goods or services, that are delivered to customers.

If the contributed items do not meet all of these criteria, they are likely to be considered a group of assets rather than a business, and the transaction would be accounted for as an asset acquisition rather than a business combination.

Real-Life Example: Airbus and Bombardier’s Joint Venture in the Commercial Aircraft Sector

In 2018, Airbus and Bombardier announced the formation of a joint venture to produce the Bombardier C Series commercial aircraft program. Under the agreement, Airbus acquired a majority stake in the C Series program, with Bombardier and the Government of Québec retaining minority interests.In this transaction, Bombardier contributed its C Series aircraft business, including the intellectual property, production facilities, and workforce, to the newly formed joint venture. Airbus, on the other hand, contributed its global scale, procurement power, and access to a broader customer base.From an accounting perspective, Bombardier would have assessed whether the contributed C Series business met the definition of a business under IFRS 3. Given the presence of inputs (such as the intellectual property and workforce), processes (the production facilities and manufacturing capabilities), and outputs (the C Series aircraft), the C Series business likely qualified as a business combination.As a result, Bombardier would have applied the acquisition method of accounting, recognizing its share of the joint venture’s identifiable net assets at fair value and accounting for any goodwill or gain on a bargain purchase. This would have involved the following key steps:

1. Determining the fair value of the identifiable net assets: Bombardier would have engaged in a valuation exercise to determine the fair value of the C Series program’s assets and liabilities, including intangible assets such as the aircraft design and customer relationships.
2. Recognizing Bombardier’s share of the net assets: Bombardier would have recognized its proportionate share of the joint venture’s identifiable net assets, based on its ownership interest in the arrangement.
3. Accounting for goodwill or gain on a bargain purchase: If the fair value of the net assets exceeded the consideration contributed by Bombardier, a gain on a bargain purchase would have been recognized. Conversely, if the consideration exceeded the fair value of the net assets, Bombardier would have recognized goodwill.

Theoretical Aspect: Substance over Form

From a theoretical perspective, the accounting for the transfer of businesses in joint venture formations is guided by the principle of substance over form. This principle, which is a fundamental tenet of IFRS, requires entities to account for transactions based on their economic substance rather than their legal form.In the context of joint venture formations, the substance of the transaction is the acquisition of a business, even though the legal form may be the establishment of a new joint venture entity. By applying the acquisition method of accounting, the contributing entity can ensure that the financial statements faithfully represent the economic reality of the transaction, providing users with more relevant and reliable information.

Practical Aspect: Valuation Challenges
One of the practical challenges in accounting for the transfer of businesses in joint venture formations is the valuation of the contributed assets and liabilities. Determining the fair values of the identifiable net assets, particularly intangible assets such as intellectual property and customer relationships, can be a complex and subjective exercise.To address this challenge, entities often engage independent valuation experts to assist in the fair value measurement process.

These experts can provide guidance on the appropriate valuation methodologies, such as the income approach or the market approach, and help entities arrive at reliable fair value estimates.Additionally, entities must carefully consider the impact of any synergies or cost savings that may arise from the joint venture formation, as these factors can influence the fair value of the contributed business and the resulting accounting treatment.By navigating the theoretical and practical aspects of accounting for the transfer of businesses in joint venture formations, entities can ensure that their financial reporting accurately reflects the economic substance of these complex transactions, providing investors and stakeholders with a more transparent and informative view of the joint venture’s financial position and performance.