Types of joint arrangement

There are two types of joint arrangement for accounting purposes: joint operations; and joint ventures. Classification depends on the rights and obligations that arise from the contractual arrangement. An entity that shares joint control needs to look at the contractual arrangement’s substance and apply judgement, to determine whether it is party to a joint operation or a joint venture.

The arrangement is a joint operation where the contractual agreement provides rights to assets and obligations for liabilities for those parties sharing joint control. Parties who share joint control over a joint operation are called joint operators.

The joint arrangement is a joint venture where the agreement grants rights to the arrangement’s net assets. The parties who share the joint control over a joint venture are called joint venturers. Reference to ‘net assets’ indicates that the joint venturer has an investment in the arrangement. Venturers could also have a net liability involvement in the joint venture.

Management assesses the parties’ rights and obligations arising from the arrangement, as they exist in the ‘normal course of businesses. Legal rights and obligations arising in circumstances other than in the ‘normal course of business’, such as liquidation and bankruptcy, are less relevant. For example, secured creditors have the first right to the assets if a vehicle is liquidated; the venture partners only have rights in the net assets remaining after settling all third-party obligations. The vehicle could still be classified as a joint operation because, in the ‘normal course of business’, the venture partners have direct interests in assets and liabilities.

Classification based on an analysis of rights and obligations IFRS 11 sets out four separate aspects to be considered in determining whether a joint arrangement is a joint operation or a joint venture, and this can be translated into a four-step approach, as outlined below. It will not always be necessary to go through all four steps. Indeed, for some joint operations, the analysis will be complete after Step 1. It is necessary to exercise judgement whenever an entity is assessing whether a joint arrangement is a joint operation or a joint venture. The entity makes the determination by considering its rights and obligations arising from the arrangement. Classification follows from an analysis of the parties’ rights and obligations arising, in the normal course of business, from the joint arrangement. When an entity has rights to the assets, and has obligations for the liabilities relating to the joint arrangement, that arrangement is classified as a joint operation. However, when an entity has rights only to the net assets of the joint operation, that arrangement is classified as a joint venture. As discussed below, IFRS 11 describe the assessment that is required to determine whether an arrangement should be classified as a joint operation or a joint venture. In order to determine whether a joint arrangement is a joint operation or a joint venture, the parties’ rights and obligations are assessed. IFRS 11 requires the following to be considered: 1.      (a) the structure of the joint arrangement; and 2.      (b) when the joint arrangement is structured through a separate vehicle: 1.                                    (i) the legal form of the separate vehicle; 2.                                    (ii) the terms of the contractual arrangement; and 3.                                    (iii) when relevant, other facts and circumstances.

Limited liability company Question: Can a limited liability company be classified as a joint operation? Answer: Yes. Secured creditors will always have the first right to the assets of a limited liability company in case of liquidation or bankruptcy. Venture partners (in the capacity of shareholders) only have rights in the net assets remaining after settlement of liabilities of all third-party obligations. Whilst this would appear to mean that a limited liability company can never be classified as a joint operation, such an entity could nevertheless be classified as a joint venture or a joint operation depending on other facts and circumstances. That is because the standard states that assessment of rights and obligations should be done as they exist in the normal course of business and not in such extreme circumstances.

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Reassessment of classification of a joint arrangement It may become necessary to re-perform the analysis described if facts and circumstances change subsequent to the initial classification of the joint arrangement. Note that reassessment of the classification of a joint arrangement will not always lead to reclassification of the joint arrangement. Such a reassessment should be based on a careful analysis of the parties’ rights and obligations following the change in facts and circumstances, and may result in a conclusion that the original classification remains valid. A reassessment of the classification of a joint arrangement is triggered if the change in facts and circumstances substantively affects the parties’ rights and obligations in respect of the joint arrangement and was not part of the purpose and design of the joint arrangement at its inception (or, if later, at the last reassessment of its classification). Reassessment will most commonly be triggered by a change in the legal structure of the joint arrangement, or in the contractual terms between the parties and the joint arrangement in a way that was not previously part of the purpose and design of the joint arrangement. Examples of such changes include: a transfer of all assets and liabilities of the joint arrangement into, or out of, a separate vehicle that confers separation between the parties to the joint arrangement and those assets and liabilities. the signing, or cancellation, of a contract requiring the parties to the joint arrangement to purchase substantially all of its output. amendments to the terms of the contractual arrangement between the parties to the joint arrangement to introduce or remove an obligation on those parties for third-party liabilities of the joint arrangement; and amendments to the terms of the joint arrangement arising from a change in the parties that have joint control. It is also possible that a reassessment may be required when there is a change in a contractual relationship between the joint arrangement and a third party (e.g. the cancellation of a joint arrangement’s only third-party sales contract with no intention to enter into another, when there is an existing obligation on the parties to the joint arrangement to take all output not taken by third-party customers). In rare circumstances, a change in facts and circumstances other than a change in contractual terms or relationships may result in a requirement to reassess the classification of a joint arrangement if that change was not contemplated at the inception of the arrangement. For example, the parties to a joint arrangement may have an obligation to purchase the primary product from a mining operation. The discovery of substantial by-product deposits, the existence of which was not contemplated when the project was planned, may subsequently give rise to substantial third-party sales which, had they been contemplated in the initial purpose and design, would have pointed to a joint venture arrangement. In addition, a change in contractual terms between the parties could lead to a requirement to reassess whether the parties continue to have joint control of the arrangement.

Unit of account

Sometimes the parties to a joint venture are bound by a framework agreement that sets up the general contractual terms for undertaking one or more activities. The framework agreement may set out that the parties establish different joint arrangements to deal with specific activities that form part of the agreement. Even though those joint arrangements are related to the same framework agreement, their type might be different if the parties’ rights and obligations differ when undertaking the different activities dealt with in the framework agreement. Consequently, joint operations and joint ventures can coexist when the parties undertake different activities that form part of the same framework agreement.

Classification of a joint arrangement: unit of account The unit of account of a joint arrangement (i.e. the level at which the assessment of the rights and obligations of the parties to the joint arrangement is made) is the ‘activity’ that two (or more) parties have agreed to control jointly. A party should assess its rights to the assets, and obligations for the liabilities, in relation to that activity. IFRS 11 does not provide any explicit guidance as to what constitutes an activity, nor does it discuss how broadly that term may be interpreted. In some instances (e.g. when the joint arrangement has a clearly established objective that is set out in a single contractual arrangement and the arrangement is wholly structured through a single vehicle), the unit of account of the arrangement is clearly identifiable. In other instances, when the structure of the joint arrangement is more complex, a more extensive analysis is required to identify the underlying activity/activities and to determine if the joint arrangement should be analysed at a lower level than the entire arrangement. This analysis can be particularly challenging when the arrangement involves multiple vehicles and/or multiple discrete activities. In such situations, it is necessary to consider the purpose and design of the arrangement, and to ensure that a robust analysis of the rights and obligations is undertaken in order to determine the appropriate level at which to determine classification.

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Unit of account: joint operations and joint ventures within a single framework agreement As contemplated in IFRS 11 (see above), two (or more) entities may enter into a single framework agreement that establishes the contractual terms for undertaking more than one activity. These activities may then be structured in various ways, for example: a separate vehicle may be established to undertake each activity; or a combination of separate vehicles and other structures involving the direct holding of assets and the direct incurrence of obligations for liabilities may be established for undertaking the various activities. The appropriate classification of a joint arrangement should be considered at the activity level, irrespective of whether a number of activities have been entered into under a single framework agreement. Although related to the same framework agreement, if the parties’ rights and obligations differ when undertaking different activities set out in the framework agreement, then more than one joint arrangement will exist and the classification of those joint arrangements may differ. It is possible that joint operations and joint ventures can co-exist within structures of this nature. When dealing with a framework agreement and the undertaking of multiple activities, care should be taken to ensure that the unit of account and corresponding classification of each joint arrangement appropriately reflects the true nature of the rights and obligations established by the joint arrangements. Each joint arrangement identified must generally relate to a specific activity and the resulting classification and accounting must reflect the rights and obligations related to that activity.

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Unit of account: more than one activity conducted through a single vehicle When a joint arrangement is established through a single contractual arrangement, and that arrangement is wholly structured through a single vehicle that holds all of the assets and liabilities related to the joint arrangement, the appropriate unit of account will typically be the vehicle. In such circumstances, the assessment of the rights and obligations of the parties to the joint arrangement should be carried out at the vehicle level. However, some joint arrangements are structured so that multiple activities are conducted through a single vehicle. If this is the case, it is necessary for the parties to the arrangement to consider their rights and obligations at the activity level, and to carry out a separate assessment of each activity to determine whether the activity is a joint operation or a joint venture. It is possible that several joint arrangements exist within the same separate vehicle. This conclusion is supported by IFRS 11 which states that “within the same separate vehicle, the parties may undertake different activities in which they have different rights to the assets, and obligations for the liabilities, relating to these different activities resulting in different types of joint arrangements conducted within the same separate vehicle”. However, the Board did note that, while such situations are possible, they are expected to be rare in practice.

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Joint arrangement with multiple pre-determined phases of activity When a project involves a number of pre-determined phases of activity, and the rights and obligations of the parties vary from one phase of activity to the next, the classification of the joint arrangement should be based on an assessment of the rights and obligations across the life of the arrangement, rather than separate assessments being performed for each phase of its activities. For example, two parties establish a joint arrangement within a separate vehicle whose legal form confers separation between the jointly controlling parties and the assets and liabilities of the vehicle (i.e. the legal form of the vehicle does not preclude classification as a joint venture). The purpose of the joint arrangement is to develop residential property on a single site funded solely by cash received from the two parties under the terms of a cash call arrangement until such time as sales of properties from the site to third parties commence. Thereafter, the arrangement requires that proceeds from sales of properties are used to fund further development costs of the site, with any surplus funds to be remitted to the parties to the arrangement. The parties’ obligation to fund cash calls continues after the commencement of third-party sales, but only in the event that cash receipts from sales are insufficient to fund development costs in a particular period. Following completion of development and sales on the site, any remaining funds will be remitted to the parties to the arrangement in proportion to their relative ownership interests and the joint arrangement will cease to exist. The activity of the joint arrangement might be considered to have two distinct phases: a development phase during which the joint arrangement is entirely dependent on the parties to the arrangement for cash to settle all liabilities; and a sales phase during which the joint arrangement generates its own cash inflows, which are then used to settle its liabilities. During the development phase, the parties have an obligation to fund the settlement of the liabilities of the joint arrangement, but during the sales phase they have no such obligation because the joint arrangement is generating independent cash inflows. The joint arrangement classification should be based on an assessment of rights and obligations resulting from contractual arrangements in place across its life, resulting in classification as a joint venture in the circumstances described. In order for the parties to a joint arrangement to be considered to have obligations for the liabilities relating to the activity conducted through the joint arrangement, it must be dependent upon the parties ‘on a continuous basis’. To be considered to have rights to the assets of a joint arrangement, the parties must share ‘substantially all the economic benefits’ of those assets. The assessment should be made at the inception of the joint arrangement based on the parties’ rights and obligations over its entire planned life. In the circumstances described, at inception the joint arrangement: is not designed such that the parties to the joint arrangement will fund its liabilities throughout its life and, therefore, the parties should not be considered to have obligations for its liabilities on a continuous basis (as discussed, a cash call arrangement operating on an ‘as needed’ basis for the purposes of funding a shortfall in cash is not sufficient to conclude that the parties have obligations for a joint arrangement’s liabilities); and is not designed such that the parties to the joint arrangement will have rights to its assets because the joint arrangement will make sales of property to third parties and retain the proceeds for use in further development on the site. Therefore, the joint arrangement should be classified as a joint venture throughout its planned life. By contrast, and as discussed, a change in the activities of a joint arrangement resulting from a change to the contractual terms of the arrangement (or from a new contract), or from a significant change in facts and circumstances not contemplated at the inception of the joint arrangement, is a trigger for reassessment of the classification of the joint arrangement when the change occurs.

An entity should re-assess whether the type of joint arrangement has changed if facts and circumstances change.

Joint arrangement with multiple potential phases of activity In some industries (e.g. the extractive and pharmaceutical industries), there may be significant uncertainty as to whether a project will proceed from one phase of activity to the next (e.g. from the exploration/research phase to the development phase, and subsequently from the development phase to the production phase). In such industries, joint arrangement contracts may be structured so that they cover all possible phases of the arrangement (i.e. the entire potential life of the project), even though it will be necessary for the parties to make future decisions as to whether to progress from one phase to the next. Alternatively, because of the inherent uncertainties, the parties may choose to put in place a written agreement at the beginning of each phase that covers only that phase of activity, or perhaps have an unsigned ‘draft’ agreement that covers all phases but that is subject to change as necessary when decisions are taken on progression to the next phase. When a contractual agreement is in place that covers all possible phases of a joint arrangement, the assessment of the parties’ rights and obligations should cover the whole of the life of the arrangement assuming successful progression through all phases regardless of the probability of proceeding to later phases. As discussed, classification of a joint arrangement should only be reassessed when there is a change in legal or contractual terms that was not previously part of the purpose and design of the arrangement, or a change in facts and circumstances that was not contemplated at the inception of the arrangement. Contractually agreed terms for later phases are part of the purpose and design of the arrangement and provide evidence that the later phases were contemplated at inception. As such, activation of those terms would not be a trigger for reassessment; the initial classification should already have considered these terms. When the joint arrangement contract does not cover all possible phases of a joint arrangement, the starting point for the assessment of rights and obligations is that contract and the phases that it does cover. However, it is also necessary to consider whether there is objective evidence that an agreement covering a longer period exists. For example (1) side agreements, (2) an overall framework agreement, or (3) agreed statements of the purpose and design or objectives may limit the courses of action open to the parties to the joint arrangement and demonstrate that the purpose and design of the joint arrangement’s later phases has already been determined. If such evidence covering a longer period exists, it should be included in the classification assessment.

Agreement covers more than one activity

Sometimes, parties enter into an umbrella arrangement, under which they establish numerous joint activities, or they might house more than one activity in one separate legal entity. “The unit of account of a joint arrangement is the activity that two or more parties have agreed to control jointly.” Management should assess each activity separately for classification as a joint operation or a joint venture. It might conclude that some activities are joint operations and others are joint ventures. Where the parties identify both joint operations and joint ventures in an arrangement, they account for each of them separately.

Step 1: structure of the joint arrangement

Step 1 involves an assessment as to whether the joint arrangement is structured through a ‘separate vehicle’.

IFRS 11 establishes a clear rule that if a joint arrangement is not structured through a separate vehicle, it should be classified as a joint operation. This is because the underlying contractual arrangement in such circumstances establishes rights to the assets and revenues, and obligations for liabilities and expenses, of the joint arrangement.

Joint arrangements can be established for a variety of purposes (e.g. to share costs, to share risks, to give access to a new market or to give access to new technology). They can also be established using different structures and legal forms, some using a separate vehicle.

IFRS 11 defines a separate vehicle as a separately identifiable financial structure, including separate legal entities or entities recognised by statute, regardless of whether those entities have a legal personality.

Examples of separate vehicles include, but are not limited to, limited liability companies, unlimited companies, partnerships and trusts.

When a joint operation is not structured through a separate vehicle, Step 1 provides a conclusive determination that the joint arrangement should be classified as a joint operation. When a joint arrangement is structured through a separate vehicle, it is necessary to move to Step 2.

Step 2: legal form of the separate vehicle

Step 2 is to consider the legal form of the vehicle to assess whether the parties have either (1) rights to the assets and obligations for the liabilities in that separate vehicle (notwithstanding the existence of the separate vehicle), or (2) rights only to the net assets of the separate vehicle.

When the legal form of the separate vehicle does not confer separation between the parties and the separate vehicle (i.e. the assets and liabilities held in the separate vehicle are regarded legally as the assets and liabilities of the parties), Step 2 provides a conclusive determination that the joint arrangement should be classified as a joint operation.

Assessment as to whether the legal form of a separate vehicle confers separation between the parties to the arrangement and the vehicle In many cases, the legal form of the separate vehicle will be such that the separate vehicle must be considered in its own right (i.e. the assets and liabilities held in the separate vehicle are those of the separate vehicle and not those of the parties to the arrangement), providing an initial indication that the joint arrangement is a joint venture. However, this is not always the case and, in some situations, the existence of a legal entity will not directly affect the rights and obligations of the parties to the assets and liabilities. One type of legal structure that, in itself, does not generally have a substantive effect on the rights and obligations of the interested parties is a ‘bare’ trust. Such trusts are commonly used in real estate development activities in some jurisdictions to access tax exemptions. Typical features include: the establishment of a trust to hold title to property in which the parties to the joint arrangement have an undivided interest; the trustee is merely vested with the legal title to property and has no other duty to perform, responsibilities to carry out, or powers to exercise as trustee of the trust property; the trust does not hold the beneficial ownership interest of the property and, consequently, has no rights to the economic benefits of the property; the beneficial ownership interest in the property is normally held by the parties to the arrangement directly or by another vehicle within the structure; and the trustee is obliged to convey legal title to the trust property on demand by, and according to the instructions of, the parties to the joint arrangement. In a structure of this nature, the trust is used by the parties to the joint arrangement solely to hold legal title. The trust has no rights to the economic benefits generated by the property. In practice, joint arrangements that establish a bare trust to hold real estate will frequently be more complex than the situation described above and this will require additional analysis. For example, a bare trust may be established in conjunction with another vehicle which holds other assets and liabilities relating to the parties to the arrangement. In such circumstances, consideration will need to be given as to the appropriate unit of account. When an entity is able to conclude that the legal form of the vehicle gives the parties rights to the assets and obligations for the liabilities relating to the arrangement, then the arrangement is a joint operation. In the absence of such a conclusion, the entity should proceed to consider the effect of the terms of the contractual arrangement between the parties (Step 3 and, when relevant, other facts and circumstances (Step 4).

Step 3: assessing the terms of the contractual arrangement

Assessing the terms of the contractual arrangement – general

Step 3 is to consider whether the contractual arrangement reverses or modifies the rights and obligations conferred by the legal form of the separate vehicle. In many cases, the terms of the contractual arrangement will be consistent, or will not conflict, with the rights and obligations conferred by the legal form. However, when the terms of the contractual arrangement override the legal form of the separate vehicle with the result that the parties have rights to the assets, and obligations for the liabilities, of the joint arrangement, that joint arrangement is classified as a joint operation.

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Example Contractual modifications Assume that two parties structure a joint arrangement in an incorporated entity. Each party has a 50 per cent ownership interest in the incorporated entity. The incorporation enables the separation of the entity from its owners and as a consequence the assets and liabilities held in the entity are the assets and liabilities of the incorporated entity. In such a case, the assessment of the rights and obligations conferred upon the parties by the legal form of the separate vehicle indicates that the parties have rights to the net assets of the arrangement. However, the parties modify the features of the corporation through their contractual arrangement so that each has an interest in the assets of the incorporated entity and each is liable for the liabilities of the incorporated entity in a specified proportion. Such contractual modifications to the features of a corporation can cause an arrangement to be a joint operation.

When the terms of the contractual arrangement do not result in the parties having rights to the assets and obligations for the liabilities of the joint arrangement, it is necessary to move to Step 4.

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Obligation to repay third-party borrowings – example Entity E and Entity F (the parties) enter into a contractual agreement to incorporate a new entity, Entity G, to manufacture materials required by the parties for their own, individual manufacturing processes. Each party has a 50 per cent ownership interest in Entity G and made a cash subscription for its equity investment. The contractual agreement is such that the parties jointly control Entity G. The legal form of Entity G does not confer rights to the assets, and obligations for the liabilities, of Entity G on its shareholders. The purpose of the arrangement is to provide the parties with the output they require and each party is required to purchase half of the total output produced by Entity G. The equity subscribed by the parties is not sufficient to fund the initial equipment costs; consequently, Entity G takes out a long-term loan from a bank over which both Entity E and Entity F provide a guarantee. The terms of the agreement are silent as to how the third-party debt is to be settled. Entity E and Entity F have rights to the assets and obligations for the liabilities relating to the joint arrangement (Entity G), including the third-party borrowings. The terms of the agreement are such that the parties have an obligation to purchase all of Entity G’s output and there are no expected sales to third parties. Consistent with example above, this leads to the conclusion that the parties have a right to the assets of the joint arrangement. The assessment as to whether the parties have the obligation for the liabilities relating to the joint arrangement (including the third-party borrowings) must take into consideration whether the parties have the primary, ongoing obligation to settle the liabilities. Based on the purpose and design of the arrangement and the requirement to purchase all of the output, the parties are the only ongoing source of cash for the arrangement. At the time the principal becomes repayable, if the cash from the parties for the purchase of output has not been sufficient to fund repayment, there appear to be a number of ways to settle the third-party borrowings: the parties fund the repayment (either by providing additional cash to Entity G or by paying the bank directly possibly through exercise of the guarantee); or the parties decide to reduce the capacity or wind up the arrangement by selling assets to generate funds to settle the liability, or by selling Entity G (including its borrowings) to another third party. Each of these methods will require the parties to provide substantially all of the cash flows required to settle the third-party borrowings by using either their own assets or assets of the arrangement to which they have rights. The assessment of the purpose of the arrangement together with the obligation of the parties to purchase output is sufficient to conclude that the parties have substantially all the obligation for the liabilities of the arrangement. Although in this case the guarantee to the bank provides another means by which the parties could provide cash to settle the borrowings, in the absence of such a guarantee the same conclusion would be reached because the borrowings would still be settled by assets of the parties or assets to which they have rights.

Step 4: other facts and circumstances

Other facts and circumstances – general considerations

Step 4 (the final step) is to consider other facts and circumstances in order to assess whether, despite the conclusions reached in Steps 1 to 3, the parties do in fact have rights to the assets and obligations for the liabilities of the arrangement, in which case the arrangement is classified as a joint operation. If this is not so, the arrangement is classified as a joint venture.

Assessment of ‘other facts and circumstances’ When a joint arrangement is structured through a separate vehicle, and neither (1) the legal form of the joint arrangement, nor (2) the terms of the contractual arrangement give the parties rights to the assets, and obligations for the liabilities, relating to the joint arrangement, it is necessary to consider whether there are any other facts and circumstances to demonstrate that the parties to the arrangement have rights to the assets, and obligations for the liabilities, relating to the joint arrangement. If not, the joint arrangement should be classified as a joint venture. Other facts and circumstances should be considered to determine whether they create enforceable rights to the assets of the joint arrangement and enforceable obligations for its liabilities sufficient to override the rights and obligations conferred upon the party by the legal form of the separate vehicle. In order to classify the joint arrangement as a joint operation as a result of assessing other facts and circumstances, it is therefore necessary to demonstrate that the parties to the arrangement: have rights and obligations related to economic benefits of the assets of the arrangement; and are obliged to provide cash to the arrangement through enforceable obligations, which is used to settle the liabilities of the joint arrangement on a continuous basis. The consideration of other facts and circumstances is not a test of whether each party to the joint arrangement is closely or fully involved with the operation of the separate vehicle. Two joint arrangements with otherwise similar features can be classified differently if one is structured through a separate vehicle and the other is not because: the legal form of a joint arrangement could affect rights and obligations; and the legal form of a joint arrangement structured through a separate vehicle must be overridden by other contractual arrangements or specific other facts and circumstances for the joint arrangement to be classified as a joint operation; but a joint arrangement that is not structured through a separate vehicle is always classified as a joint operation. See May 2014 and March 2015 IFRIC Updates for a summary of the IFRS Interpretations Committees deliberations on this topic.

Parties obliged to purchase substantially all of the output of the arrangement

If two or more parties establish a joint arrangement, the output of which is provided to the parties themselves with sales to third parties being precluded, this indicates that the parties have rights to substantially all the economic benefits of the arrangement’s assets. If sales to third parties are precluded, the cash that the parties pay to the arrangement may be substantially the arrangement’s only source of income; this means that the parties are providing the cash to settle the arrangement’s liabilities and indicates that the parties have an obligation for the liabilities relating to the arrangement.

Example Assessing other facts and circumstances (parties obliged to purchase substantially all of the output of the arrangement) Assume that two parties structure a joint arrangement in an incorporated entity (entity C) in which each party has a 50 per cent ownership interest. The purpose of the arrangement is to manufacture materials required by the parties for their own, individual manufacturing processes. The arrangement ensures that the parties operate the facility that produces the materials to the quantity and quality specifications of the parties. The legal form of entity C (an incorporated entity) through which the activities are conducted initially indicates that the assets and liabilities held in entity C are the assets and liabilities of entity C. The contractual arrangement between the parties does not specify that the parties have rights to the assets or obligations for the liabilities of entity C. Accordingly, the legal form of entity C and the terms of the contractual arrangement indicate that the arrangement is a joint venture. However, the parties also consider the following aspects of the arrangement: The parties agreed to purchase all the output produced by entity C in a ratio of 50:50. Entity C cannot sell any of the output to third parties, unless this is approved by the two parties to the arrangement. Because the purpose of the arrangement is to provide the parties with output they require, such sales to third parties are expected to be uncommon and not material. The price of the output sold to the parties is set by both parties at a level that is designed to cover the costs of production and administrative expenses incurred by entity C. On the basis of this operating model, the arrangement is intended to operate at a break-even level. From the fact pattern above, the following facts and circumstances are relevant: The obligation of the parties to purchase all the output produced by entity C reflects the exclusive dependence of entity C upon the parties for the generation of cash flows and, thus, the parties have an obligation to fund the settlement of the liabilities of entity C. The fact that the parties have rights to all the output produced by entity C means that the parties are consuming, and therefore have rights to, all the economic benefits of the assets of entity C. These facts and circumstances indicate that the arrangement is a joint operation. The conclusion about the classification of the joint arrangement in these circumstances would not change if, instead of the parties using their share of the output themselves in a subsequent manufacturing process, the parties sold their share of the output to third parties. If the parties changed the terms of the contractual arrangement so that the arrangement was able to sell output to third parties, this would result in entity C assuming demand, inventory and credit risks. In that scenario, such a change in the facts and circumstances would require reassessment of the classification of the joint arrangement. Such facts and circumstances would indicate that the arrangement is a joint venture.

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Parties to the joint arrangement are obliged to purchase all output at a market price or a fixed price The same conclusion as that reached in example above will not necessarily be reached if, instead of the parties purchasing output at a variable price calculated to ensure that the joint arrangement operates at a break-even level, the parties are obliged to purchase all of the output at the output’s current market value or at a fixed price. Classification as a joint operation requires that the parties have both rights to the assets and obligations for the liabilities relating to the arrangement. If the price of the output changed in the manner described, the parties would still have rights to the assets of the joint arrangement through their obligation to purchase output. In determining whether the parties would also have obligations for the liabilities of the joint operation, it is necessary to consider whether the cash flows provided to the joint arrangement through the parties’ purchase of the output from the joint arrangement at a market or fixed price, along with any other funding that the parties are obliged to provide, would be sufficient to enable the joint arrangement to settle its liabilities on an ongoing basis. As reported in the March 2015 IFRIC Update, the IFRS Interpretations Committee discussed a fact pattern in which the output is sold to the parties of the joint arrangement at a market price. The Committee observed that “the sale of output from the joint arrangement to the parties at market price, on its own, is not a determinative factor for the classification of the joint arrangement” and that “exercising judgement is needed in this situation in order to determine whether the arrangement is a joint operation”. In making the assessment as to whether the parties have obligations for the liabilities of the joint arrangement, it is necessary to consider: whether there exists a genuine possibility that the price paid by the parties for the arrangement’s output will be inadequate for it to settle its liabilities on an ongoing basis; and, if so, whether the parties have committed to make good any shortfall through another mechanism (e.g. a cash call or other contingent funding requirement) such that they are obliged to provide sufficient cash to settle the arrangement’s liabilities. If, based on factors such as the expected excess of sales price over the costs of the joint arrangement and any expected volatility in costs and (if relevant) market price, it is concluded that there is no genuine possibility of a shortfall, or a mechanism exists requiring the parties to make good any shortfall that occurs, the parties would be considered to have obligations for the liabilities of the arrangement and, consequently, classification as a joint operation would be appropriate. If there is a genuine possibility of a shortfall that the parties are not obliged to make good in cash, it would then be necessary to consider how the funds needed to meet the shortfall would be obtained. If, in such circumstances, the parties would require the joint arrangement to sell other assets to which the parties have rights then, the parties would still be considered to have obligations for the liabilities of the arrangement, and classification as a joint operation would still be appropriate. If there is a genuine possibility that a more than insignificant portion of the liabilities of the joint arrangement will be settled by selling assets of the joint arrangement to which the parties do not have rights, it will be appropriate to conclude that the parties do not have obligations for the liabilities of the arrangement and, consequently, that classification as a joint venture is appropriate.

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Meaning of ‘substantially all’ in the context of IFRS 11 As outlined, as an example of ‘other facts and circumstances’ that might suggest classification as a joint operation, IFRS 11 discusses a scenario in which the activities of an arrangement are primarily designed for the provision of output to the parties to the joint arrangement such that the parties have rights to ‘substantially all’ the economic benefits of the assets of the arrangement. IFRS 11 does not provide any additional guidance on what is meant by ‘substantially all’ in this context. The issue of determining the basis for ‘substantially all’ of the output was discussed by the IFRS Interpretations Committee who, as reported in the March 2015 IFRIC Update, concluded that this assessment is based on the monetary value of the output and not physical quantities. If the arrangement is such that the parties to the joint arrangement take 90 per cent or more of the monetary value of the output of the joint arrangement, this should generally be presumed to be sufficient to conclude that they have rights to substantially all the economic benefits of its assets. For a joint arrangement to be classified as a joint operation, IFRS 11 also requires that the parties to the joint arrangement have obligations for its liabilities. As discussed, this can arise from an obligation to purchase output (but not merely a right, intention and/or expectation to do so) that results in the parties being substantially the only source of cash flows contributing to the continuity of the operations of the arrangement. As with the assessment of rights to economic benefits, ‘substantially’ in this context should generally be presumed to mean 90 per cent or more of those cash flows. The assessment of whether the parties to the joint arrangement have rights to ‘substantially all’ its assets and are ‘substantially’ the only source of cash flows contributing to its operations should be made at inception of the joint arrangement and should only be reassessed if there is a change in the parties’ rights to the assets or obligation for the liabilities. The assessment should take into account the expected output and costs of the joint arrangement over its life (rather than only in the current or subsequent reporting periods). Further, it should consider the purpose and design of the arrangement, including the following factors. Pricing When the joint arrangement produces more than one product, or sales to third parties are priced differently from sales to parties to the arrangement, it will be necessary to consider the monetary value (price) of output rather than its physical quantity in making the assessment of what proportion of output the parties to the joint arrangement take and what proportion of cash flows they provide. Frequency and duration of sales to third parties Third-party sales may be permitted to occur from time to time as a result of a temporary condition or event. If sales of output to third parties are otherwise precluded by the contractual terms of the arrangement or are not expected to occur, it may be that the parties to the arrangement have rights to substantially all of the economic benefits of the assets of the arrangement over its life. This is less likely to be the case if the joint arrangement vehicle is actively marketing to third parties on an ongoing basis. By-products Third-party sales of a by-product of the joint arrangement’s principal operations might occur on an ongoing basis but should still be considered in determining whether the purpose and design of the arrangement is primarily to provide output to the parties to the arrangement. In addition, it is necessary to consider whether cash flows from sales of by-products to third parties make a significant contribution to the operations of the arrangement (and, consequently, whether the parties to the joint arrangement can be considered to have an obligation for its liabilities). Other factors may also be relevant depending on the specific attributes of the joint arrangement. An entity would need to consider such factors and determine whether, in situations which appear to lack clarity, the vehicle is primarily servicing the designated output requirements of the parties to the joint arrangement.

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Parties intend and expect to purchase substantially all of the output of the arrangement, but no obligation to do so If the facts in example above were changed such that the parties to the joint arrangement have a right, expectation and/or intention to purchase all (or substantially all) of its output but they are not obliged to do so, classification as a joint operation would not be appropriate. IFRS 11 states that classification as a joint operation requires that the parties have rights to the assets and obligations for the liabilities relating to the arrangement. An obligation to purchase the output of a joint arrangement will be legal or contractual (either as part of the contractual arrangement between the parties to the joint arrangement or as separate, contractually binding side agreements between the parties to the joint arrangement and the joint arrangement itself) in nature. In the absence of an obligation to purchase the output of a joint operation, a right, expectation and/or intention to purchase that output is not (individually or in combination) sufficient to support a conclusion that the parties have an obligation for the liabilities relating to the arrangement; in the absence of an obligation, the parties could choose not to purchase some or all of the output, in which case the joint arrangement could sell the output to third parties and use the proceeds to settle its liabilities.

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Joint arrangement sells output to third parties on behalf of the parties to the joint arrangement If the facts in example above were changed such that, instead of the parties to the joint arrangement purchasing its output, the joint arrangement itself sells output to third parties on behalf of the parties to the joint arrangement, it would be necessary to evaluate all of the relevant facts and circumstances carefully in order to determine whether classification as a joint operation is appropriate. There may be circumstances in which it can be demonstrated that such an arrangement is equivalent to the parties to the joint arrangement purchasing its output and then selling it to third parties on their own account and, thus, that the parties have rights to the assets, and obligations for the liabilities, relating to the joint arrangement. To have rights to the assets of the joint arrangement and to assume credit risk, the parties to the joint arrangement must act as principal in the sale of output and be exposed to the risk of non-payment by third-party customers. This is most likely to be the case if the cash payments from third-party customers are received directly by the parties to the joint arrangement, and the parties make separate payments to the joint arrangement for the output irrespective of whether they have received the cash from the third-party customers. To have obligations for the liabilities relating to the joint arrangement and to assume inventory and demand risk, the parties to the joint arrangement must provide the primary source of cash on an ongoing basis to settle substantially all of the arrangement’s liabilities, including any that are not covered by the cash from third-party sales made by the joint arrangement as agent for the parties. This might be the case if the terms of the arrangement specify that the parties are obliged to purchase substantially all of the joint arrangement’s output, some or all of which may be sold to third parties by the joint arrangement as agent for the parties. As discussed, for a joint arrangement that is structured through a separate vehicle to be classified as a joint operation, it is necessary for the parties to have both rights to the assets, and obligations for the liabilities, relating to the arrangement.

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Parties that control the arrangement are the sole suppliers to the arrangement If the facts in example above were changed such that, instead of being obliged to purchase its output, the parties to the joint arrangement are obliged to act as the sole suppliers of raw materials to the arrangement (the joint arrangement is restricted from sourcing product from any alternative supplier), classification as a joint operation would not be appropriate. Unlike the circumstances described in example above, the obligation on a joint arrangement to purchase all of its supplies from the parties to the joint arrangement does not result in the parties being substantially the only source of cash flows contributing to the continuity of operations and does not give the parties rights to the assets of the joint arrangement. Consequently, in the absence of any other relevant factors, the joint arrangement is a joint venture. Assume, for example, that Entity A and Entity B establish a joint arrangement in Country X through a separate vehicle (Entity C) in order to gain access to customers in Country X. Each party has a 50 per cent interest in Entity C. The purpose of Entity C is to manufacture and sell goods to third-party customers in Country X. Entity A and Entity B will be the sole suppliers of Entity C’s requirements for raw materials, which they will sell on an ongoing basis to Entity C at fair value. Entity C in the normal course of its operations will use the proceeds from its sales to third parties to pay its liabilities, including those arising from the purchase of raw materials from Entity A and Entity B. In the circumstances described, Entity A and Entity B do not have rights to the assets of Entity C (because once the raw materials are sold to the joint arrangement, they will be used for sales to third parties) or obligations for its liabilities (because the cash to settle liabilities will be sourced from third-party sales).

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Joint arrangement produces bespoke output The consideration of ‘other facts and circumstances’ in determining the classification of a joint arrangement is not affected by whether the arrangement produces goods that could be sold to a variety of external customers (sometimes referred to as ‘fungible’ goods) or output bespoke to the requirements of the parties to the arrangement such that it is unlikely to be sold to third parties. As discussed, in the absence of an enforceable obligation to purchase the output of a joint arrangement, a right, expectation and/or intention to purchase that output is not (individually or in combination) sufficient to support a conclusion that the parties have an obligation for the liabilities relating to the arrangement. Production by a joint arrangement of bespoke output (e.g. specialised manufactured parts that may be expected to be purchased only by the parties) might lead to an expectation or intention that the parties will purchase that output but it does not, in itself, oblige them to do so. The IFRS Interpretations Committee confirmed in the March 2015 IFRIC Update that “the focus of ‘obligation for the liabilities’ in IFRS 11 is on the existence of cash flows flowing from the parties to satisfy the joint arrangement’s liabilities as a consequence of the parties’ rights to, and obligations for, the assets of the joint arrangement, regardless of the nature of the product (ie fungible or bespoke output)“. [Emphasis added]

Differences between joint operations and joint ventures

Appendix B to the Standard sets out a table comparing common terms in contractual arrangements of parties to a joint operation and common terms in contractual arrangements of parties to a joint venture.

The examples in the table, which is reproduced below, are not exhaustive.

Classification flow chart

The following flow chart summarises how to determine the classification of a joint arrangement.

A. Is the arrangement structured through a separate vehicle?

Joint arrangement not in a separate vehicle

A separate vehicle is defined by the standard as “… a separately identifiable financial structure, including separate legal entities or entities recognised by statute, regardless of whether those entities have a legal personality”. A separate vehicle has a distinct structure, such as an organisation or institution. It will often be an organisation that exists separately from its members. Examples include a corporation, partnership, trust, government body or agency, university or any other organisation or body of persons.

An arrangement that is not structured through a separate vehicle is a joint operation. Each party in a joint operation usually uses its own resources and carries out its own part of a joint operation separately from the activities of the other party or parties. Each party incurs its own expenses and raises its own financing.

The contractual arrangement governing the operation is likely to specify how revenues, common expenses and assets and liabilities are to be shared among the operators. For example, two or more investors combine their operations, resources and expertise in order to manufacture jointly a particular product in a joint operation. Each party carries out a different part of the manufacturing process. Each party bears its own costs, and it takes a share of the revenue from the sale of the product; this share is determined in accordance with the contractual arrangement.

Joint operation not in a separate vehicle Three separate aerospace companies form an alliance to jointly manufacture an aircraft. They carry responsibility for different areas of expertise, such as: ·        manufacturing engines; ·        manufacturing fuselage and wings; and ·        aerodynamics. The companies carry out different parts of the manufacturing process, each using its own resources and expertise in order to manufacture, market and distribute the aircraft jointly. The three entities share the revenues from the sale of aircraft and jointly incur expenses. The revenues and common costs are shared, as agreed in the consortium contract. Parties also incur their own separate costs, such as labour costs, manufacturing costs, supplies, inventory of unused parts and work in progress. Each party recognises its separately incurred costs in full. This arrangement is classified as a joint operation, because: ·        the arrangement is not structured through a separate vehicle; ·        each party has obligations for the costs that it incurs separately; and ·        the contractual agreement outlines that each party is entitled to a share of revenue and associated costs from the sale of aircraft, based on the pre-determined agreement.

The parties could agree to share and operate an asset together. This type of joint operation involves the joint ownership of the asset that is not a separate entity. It is important to establish which items of costs and revenue are shared and which are incurred separately by each party.

Examples of joint operations in the oil and gas industry Many activities in the oil, gas and mineral extraction industries involve assets that are jointly operated and owned. A common example is where two oil companies with adjoining wells build and operate a pipeline to transport oil to a refinery. The shared item is the pipeline, comprising building costs, maintenance expenses, future decommissioning costs and the potential revenue from third-party use. The separate costs that the parties incur include the cost of the stocks of oil that pass through the pipeline and any liability incurred to finance their share of the pipeline. The pipeline is directly owned by the parties and not through a separate vehicle.

Joint arrangement in a separate vehicle

A joint arrangement that is structured through a separate vehicle can be either a joint operation or a joint venture. It might be hard to differentiate between a joint venture and a joint operation, for example, where separate legal entities are used to ‘house’ joint operations for tax or other reasons.

The parties to the joint arrangement have to analyse the underlying contractual agreements, to determine whether the arrangement grants rights to assets and obligations for liabilities, or whether it grants rights to net assets.

The underlying rights and obligations of the parties need to be considered in the context of: the separate vehicle’s legal form; the terms of the contractual agreement binding the parties sharing joint control; and other relevant facts (including any restrictions imposed on the parties, the arrangement’s customer base and the parties’ funding obligations).

Where the facts change, a previous conclusion might no longer be appropriate. So, management has to re-evaluate whether the entity is a party to a joint operation or a joint venture.

B. Does the legal form confer direct rights to assets and obligations for liabilities on the parties to the arrangement?

Parties need to assess whether the legal form of the joint arrangement separates the assets and liabilities of the joint arrangement from those of the investing parties.

The arrangement is a joint operation where the legal form does not confer separation between the investors and the vehicle; that is, the venturers would remain exposed to the venture’s assets and liabilities. No further assessment is required to conclude on the classification. Partnerships, for example, would not create separation from the partners where the partners have direct rights to assets and are directly obligated for the partnership’s liabilities in the normal course of business. Similarly, unlimited liability entities often provide direct rights and obligations to the venture partners, depending on the relevant facts and circumstances. It is possible that the same legal form in different territories might lead to different results, depending on local laws and regulations.

C. Does the contractual arrangement between parties confer direct rights to assets and obligations for liabilities on the parties to the arrangement?

Terms of the contractual arrangement

The joint arrangement’s legal form is an important factor, but it might not provide sufficient evidence to classify a joint arrangement as a joint venture. The terms agreed by the venturers and other facts might reverse the separation granted by the legal form. The assessment of the terms in the contractual agreement should focus on the analysis of the rights and obligations of each party.

Parties agree on the rights and obligations that they want to share in the contractual agreement. It is most likely that they will choose a legal form that complements those rights and obligations and that does not contradict it.

Local laws might require an arrangement to be set up in a particular legal structure. The parties might want to have different rights and obligations, and so the contractual terms might modify the rights and obligations arising from the legal form.

Contractual agreement reversing the impact of legal form A large telecommunications organisation (Telecommunications company A) is seeking to establish operations in a relatively undeveloped communications environment. The in-country requirements do not allow a local entity with a telecom licence to be controlled by a foreign company. Telecommunications company A establishes a separate company with a local investor, to allow telecommunications company A to enter this market. The company’s legal form confers the rights to the assets and the obligations for liabilities to the company itself. Telecommunications company A and the local investor establish a shareholders’ agreement, which requires all decisions to be made jointly. The agreement also confirms: ·        The arrangement’s assets are owned by each venturer. ·        All legal titles are retained by the investors. ·        The venturers are liable for the venture’s obligations. ·        The company’s profits will be distributed to telecommunications company A and the investor 60:40. The arrangement is structured through a separate legal entity, but it does not have any assets of its own. The parties are liable for all obligations and claims against the company. This arrangement is a joint operation.

Common terms in contractual arrangements that provide for joint operations or joint ventures are:

The joint venturers are not liable for the joint venture’s unpaid debts and obligations. Under the equity method of accounting, the investor recognises any joint venture losses against the investment value until it has reduced to zero. The investor only recognises further losses if the venturer has a contractual or legal obligation to fund the joint venture’s losses. This guarantee to cover the losses of a joint venture or to assume this liability does not, on its own, suggest that the arrangement is a joint operation.

The arrangement is a joint operation if the parties conclude that the terms and conditions of the contractual arrangements grant rights to assets and create obligations for liabilities in relation to the arrangement. The standard does not require the parties to analyse the other facts.

Determining joint arrangement classification Three separate aerospace companies form a separate entity, J, to jointly manufacture an aircraft. They carry responsibility for different areas of expertise, such as: ·        manufacturing engines; ·        manufacturing fuselage and wings; and ·        aerodynamics. The companies carry out different parts of the manufacturing process, each using its own resources and expertise in order to manufacture, market and distribute the aircraft jointly. The three entities share the revenues from the sale of aircraft and jointly incur expenses. The revenues and common costs are shared, as agreed in the consortium contract. Parties also incur their own separate costs, such as labour costs, manufacturing costs, supplies, inventory of unused parts and work in progress. Each party recognises its separately incurred costs in full. Entity J maintains separate accounting records. The consortium agreement comprises the following: ·        Entity J will invoice the customers on the investors’ behalf. The allocation of revenue from the aircraft’s sale is in proportion to the investors’ interests. ·        All administrative costs incurred by entity J are shared by the parties in proportion to their interests; entity J will recharge these, with no additional margin. ·        The companies carry out different parts of the manufacturing process, each using its own resources and expertise to manufacture, market and distribute the aircraft jointly. ·        Each company incurs its own separate costs, such as labour costs, manufacturing costs, supplies, inventory of unused parts and work in progress. Each company recognises its separately incurred costs in full. This arrangement is classified as a joint operation, because each company has direct rights to the arrangement’s assets and obligations for the liabilities. The contractual agreement between the parties reverses the separation conferred by the legal form.

D. Other facts and circumstances

The terms and conditions in the contractual agreement do not always provide sufficient evidence to determine what type of joint arrangement the parties are entering into. Parties should look at the other facts surrounding the joint arrangement’s existence. The design and purpose of the investee can provide further evidence of the nature of the arrangement.

Agent versus principal Entities A and B agree to set up a joint arrangement through a separate entity, J. Entity J is set up to hold the assets on behalf of the investors. Entity J was set up merely to act as agent for its principals (that is, the investors), managing the assets and liabilities on behalf of the investors, to pass on to them its revenues and costs. Question: Is entity J a joint venture? Answer: No. Entity J was set up in a separate vehicle, but this is not conclusive when determining the classification of the joint arrangement. The design of the arrangement and the contractual agreements is for entity J to act as an agent of the investors. Entities A and B have rights to the assets and obligations for the liabilities of entity J. Therefore, entity J is a joint operation. Note: the determination that entity J acts as an agent of the investors is likely to affect the classification of the transactions within the joint arrangement itself. For example, revenue could be recorded net rather than gross in accordance with IFRS 15 (IAS 18).

Management should consider agreements that prevent the joint arrangement from selling its output to other market participants, because this might result in joint operation classification. The parties need to have a binding obligation that is legally enforceable to take all of the output, for the arrangement to qualify as a joint operation. The purpose and design of the arrangement follows the nature of a joint operation where a binding agreement is in place. If the parties only have a right to take the output, they might decide to take those outputs in one year but sell to outside parties in another year. The purpose and design of the arrangement is not to ensure that the output is always to be taken by the parties. The arrangement could be a joint venture.

Parties to a joint arrangement have rights to the assets of the joint arrangement through other facts and circumstances where they:

1. have rights to substantially all of the economic benefits (output) of assets of the arrangement; and
2. have obligations to acquire those economic benefits and thus assume the risks relating to those economic benefits.

Parties have obligations for liabilities of the joint arrangement through other facts and circumstances where:

a. as a consequence of their rights to, and obligations for, the assets of the joint arrangement, they provide cash flows that are used to settle liabilities of the joint arrangement; and

b. settlement of the liabilities occurs on a continuous basis.

Joint construction and use of a pipeline Two entities, A and B, form a limited liability company to build and use a pipeline to transport gas. Each entity has a 50% interest in the company. Entities A and B must each use 50% of the pipeline capacity, under their contractual terms. Unused capacity is charged at the same price as used capacity. Entities A and B can sell their share of the capacity to a third party without consent from the other investors. The price that entities A and B pay for the gas transport is determined in a way that ensures that all costs incurred by the company can be recovered. The joint arrangement is structured through a separate vehicle. Each party has a 50% interest in the company. The contractual terms require a specific level of usage by each party and, because of the pricing structure, the entities have an obligation for the company’s liabilities. This entity might be a joint operation, despite its legal form.

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Other facts and circumstances: contractual and legally enforceable terms Question: Should the assessment of ‘other facts and circumstances’ be based only on contractual and legally enforceable terms? Answer: Facts and circumstances that involve contractual and legally enforceable terms are seen as most relevant to the classification decision. Rights and obligations are, by nature, enforceable. The Interpretations Committee concluded that the assessment of the effect of ‘other facts and b. the parties agree to reimburse the arrangement for all of its costs in proportion to their shareholdings, based on cash calls. Transferring gross proceeds of revenues to the parties, and making cash calls for incurring its costs, does not indicate that the parties have rights to assets and obligations for liabilities of the arrangement. It is merely a funding mechanism. It is no different from the parties having an interest in the net results of the arrangement. circumstances on the classification of a joint arrangement should be based on enforceable terms.

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Other facts and circumstances: sale at market prices Question: Does the sale of the output from the joint arrangement to the parties at a market price prevent classification as a joint operation? Answer: Output sold at market price is not, by itself, a determinative factor for the classification of a joint arrangement; judgement needs to be exercised, to consider if the parties have rights to assets and obligations for liabilities of the joint arrangement. The Interpretations Committee observed that, in order to classify a joint arrangement as a joint operation due to other facts and circumstances, it is necessary to demonstrate that: the parties have rights and obligations relating to substantially all of the economic benefits (such as output) of the assets of the arrangement; and they provide cash to the arrangement through legal or contractual obligations, which is used to settle the liabilities of the joint arrangement on a continuous basis. The cash flow provided by the parties’ purchase of the output at market price might not be at a sufficient level to ensure that the liabilities of the arrangement are settled on a continuous basis. This might indicate that the parties have no obligation to settle liabilities. Consider a joint arrangement that produces gold, which must sell the output to the parties at the prevailing London Metal Exchange gold price. The price could fluctuate to a level that would be unprofitable for the arrangement. This might signal that the arrangement would be unable to settle its debts on a continuous basis. Alternatively, the price might be determined on a cost-plus or break-even basis. This could be seen as giving the parties not only the rights to all of the output, but also the obligation (in substance) for settling the liabilities of the joint arrangement on a continuous basis.

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Other facts and circumstances: less relevant factors Question: What factors might be less relevant when assessing other facts and circumstances? Answer: Nature of output The Interpretations Committee observed that the nature of the output, whether fungible or bespoke, does not impact the assessment of other facts and circumstances. The focus of considering obligations for liabilities is on cash flows between the parties and the joint operation, rather than the nature of the product itself. Closely and fully involved parties Consideration of other facts and circumstances is not a test of whether the parties to the joint arrangement are closely or fully involved with the operation of the separate vehicle. It is an assessment of whether other facts and circumstances override rights and obligations conferred on the parties by the legal form of the separate vehicles. Financing from a third-party Existence of a third-party financing should not, on its own, determine the classification of a joint arrangement. If the cash flows are expected to be sufficient for repayments to the third-party finance provider, it should not affect the classification of the joint arrangement.

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Other facts and circumstances: substantially all output Question: Should volumes or monetary values of output be the basis when determining ‘substantially all of the output’? Answer: Parties to the joint arrangement should have rights to substantially all of the ‘economic benefits’ of the assets of the arrangement in order to have ‘direct rights to the assets. For example, a joint arrangement produces: ·        product A, which has a higher unit value and is produced in small quantities; and ·        product B, which has a lower unit value and is produced in large quantities. The Interpretations Committee noted that economic benefits relate to the cash flows arising from the parties’ rights and obligations for the assets. It is the monetary value of the output and not the physical quantities (volume) that are more relevant. If the output of the joint arrangement above comprises substantially the sales of product A in monetary value, regardless of the fact that product B is produced in higher volumes, product A should be considered when determining substantially all of the output.

Other parties to a joint arrangement

Parties to a joint arrangement might not share control, for various reasons. Entities might take an ownership interest in shared assets, such as a pipeline, where the group of users is too wide for joint control to be practical. An entity might also enter into an arrangement where it wishes to retain influence and access to information, but it does not wish to actively share joint control. Parties to a joint arrangement who participate, but do not share joint control over it, should classify their investment according to their rights and level of participation. Parties to a joint operation who participate, but do not share joint control over it, should recognise their share of the operation’s assets and liabilities if they have rights to the assets and obligations for the liabilities.

Party to a joint arrangement Entities A, B and C enter into a joint venture, by establishing entity J as a separate legal entity. They contributed the following to the joint arrangement: ·        Entity A contributed a property with a fair value of C500. ·        Entity B contributed equipment with a fair value of C400. ·        Entity C contributed cash of C100. The articles of association grant voting rights to all parties in proportion to their contribution − that is, five votes for entity A, four votes for entity B, and one vote for entity C. Entities A and B must unanimously make decisions about entity J’s production, investing and financing activities. Entity C is a party to the joint arrangement, but it has no joint control over it, because its consent to decisions on the relevant activities is not required. It has a seat on the board of directors, but its 10% shareholding is not presumed to result in significant influence, because entities A and B actively exercise joint control. Entity C, therefore, accounts for its investment in entity J as a financial asset under IFRS 9 (IAS 39).