Accounting for joint arrangements depends on their classification as either a joint operation or a joint venture. A joint operator accounts for its share of assets, liabilities, revenues, and expenses from the arrangement. Accounting within the joint arrangement itself is outside the scope of IFRS 11.

A joint venture uses the equity method of accounting to account for its investment in joint ventures. Parties not exercising joint control account for their interest in a way that depends on the economic interest that they have in the arrangement.

A. Joint operators

Initial recognition

Where a joint operator acquires an interest in a joint operation, the accounting treatment depends on whether the activity of the acquired joint operation constitutes a business. The joint operator should apply business combination accounting to the extent of its share, where the activity of the joint operation constitutes a business. This applies to the acquisition of both the initial interest and additional interests in a joint operation in which the activity of the joint operation constitutes a business.

Accounting for joint ventures – investors not having joint control

A party that participates in a joint venture, but that does not have joint control, is required to account for its interest as follows:

• if it has significant influence over the joint venture, using the equity method as set out in IAS 28;
• otherwise, by IFRS 9 (or, for entities that have not yet adopted IFRS 9, IAS 39).

Accounting for joint operations – joint operators

Items to be recognized in relation to interests in joint operations – general

Under the approach taken in IFRS 11, a party with joint control of a joint operation has (legally or in substance) rights to the assets and obligations for the liabilities of the joint operation. IFRS 11’s requirement to recognize directly the assets, obligations, revenues, and expenses of the joint operator reflects this relationship.

A joint operator (i.e. a party that has joint control of a joint operation) recognizes the following in its financial statements in respect of the joint operation:

• its assets, including its share of any jointly held assets;
• its liabilities, including its share of any jointly incurred liabilities;
• 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.

As explained in IFRS 11, the contractual arrangement often describes the nature of the activities to be undertaken and how the parties will go about undertaking the activities; for example, parties may agree to manufacture a product together, with each party being responsible for a specific task and each using its assets and incurring its liabilities. Each joint operator in this example should recognize, in its financial statements, the assets it uses and the liabilities it incurs for the task. The contractual arrangement is also likely to specify how revenue and expenses that are common to the parties are to be shared between them and the accounting for such revenue and expenses should follow from this. IFRS 11 gives another example: parties agreeing to share and operate an asset together. The contractual arrangement sets out the parties’ rights to the jointly operated asset and how output or revenue from the asset together with operating expenses are shared between the parties. In this example, each joint operator should reflect its share of the joint asset and its agreed share of any liabilities, output, revenue and expenses in its financial statements in accordance with the contractual arrangement.

Individual assets, liabilities, revenue and expenses are thus included in the joint operator’s financial statements as its assets, liabilities, revenue and expenses. In some cases, this will follow the legal form; in other cases, it will reflect the joint operator’s interest in and exposure to balances that, legally, arise in a separate vehicle.

The IASB staff has prepared Frequently Asked Questions relating to IFRS 11, which do not constitute official IASB guidance. These note that, in the majority of cases, accounting for assets and liabilities gives the same outcome as proportionate consolidation would have done, but two main differences are identified:

• IFRS 11 requires an entity with an interest in a joint operation to recognise assets, liabilities, revenues and expenses of the joint operation as specified in the contractual arrangement, rather than basing the recognition of all assets, liabilities, revenues and expenses on the ownership interest that the entity has in the joint operation; and
• for entities that prepare separate financial statements, there is no difference between amounts recognised in the separate financial statements and in the consolidated financial statements.

Assets, liabilities, revenues and expenses of the joint operation to be accounted for in accordance with relevant IFRS Standards

The assets, liabilities, revenues and expenses are accounted for in accordance with the relevant IFRS Standards.

For example, IFRS 15 will be applied to determine the appropriate amount to be included for revenue. Similarly, the Basis for Conclusions on IFRS 11 confirms that if a joint operation is held for sale, a joint operator should account for its interest in accordance with IFRS 5.

Recognition of revenue by a joint operator – example Two parties (Entity A and Entity B) enter into a joint arrangement that is structured through a separate vehicle. Each party initially subscribes for 50 per cent of the shares in the jointly controlled vehicle and the joint arrangement agreement specifies that each party is obliged to purchase 50 per cent of the primary output of the arrangement at cost. The arrangement also generates a by-product that may be sold to third parties. By-product sales are not expected to be substantial and, as discussed, the joint arrangement is classified as a joint operation. In its first year of operation (20X1), the joint operation’s separate financial statements show revenue of CU100 constituting: CU Sales of primary product to Entity A 48 Sales of primary product to Entity B 48 Sales of by-product to third parties   4 100 During the year Entity A has sold products purchased from the joint operation of CU40 to its own customers for proceeds of CU60. In its 20X1 financial statements, Entity A should recognise revenue of CU62 in respect of its interest in the joint operation, which is calculated as follows. CU Revenue from sale of output purchased from the joint operation to external customers 60 Share of by-product sales by the joint operation (CU4 × 50 per cent)  2 62 Neither Entity A nor Entity B should recognise any revenue in respect of the joint operation’s sale of the primary product to the joint operators (i.e. themselves). This is because a joint operator that has an obligation to purchase the output from the joint operation has rights to the assets of the joint operation. Accordingly, the sale of the output by the joint operation to the joint operator would mean selling output to itself and, therefore, the joint operator should not recognise a share of the revenue from the sale of that output by the joint operation. Entity A and Entity B recognise ‘their revenue’ only when they sell the output to third parties. IFRS 11 results in the recognition of revenue by a joint operator only when the joint operation sells its output to third parties. For this purpose, ‘third parties’ does not include other parties who have rights to the assets and obligations for the liabilities relating to the joint operation. The conclusions above have been confirmed by the IFRS Interpretations Committee (see March 2015 IFRIC Update).

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Recognition of liabilities in respect of a joint operation that is not a separate vehicle As discussed, IFRS 11 requires that a joint operator recognise “its liabilities, including its share of any liabilities incurred jointly” in relation to its interest in a joint operation. In a joint operation conducted through a contractual arrangement (i.e. when there is no separate legal vehicle that can enter into contracts on its own account), one of the joint operators (‘the obligor’) will often enter into contracts with third parties for the funding or purchase of resources to be used in the activities of the joint operation. Such liabilities could include, for example: trade payables relating to the joint operation’s purchase of goods or services; employee benefit liabilities relating to employees engaged in the joint operation’s activities; borrowings entered into to fund the joint operation; or lease liabilities in respect of leased assets used by the joint. Typically, the obligor will settle the third-party liabilities directly and recover an appropriate proportion of the resulting cash outflow from the other parties to the joint operation either through taking an additional share of output or cash receipts from the joint operation or by receiving settlement directly from the other parties. When the obligor is the sole party with direct responsibility for the contractual obligation to the third party (as distinct from an arrangement under which all parties to the joint operation have a direct contractual relationship with the third party and have, potentially, incurred the liability jointly), the question arises as to how the arrangement should be reflected in the statement of financial position of each joint operator. Financial statements of the obligor The obligor should recognise the obligation to the third party in its entirety to reflect the legal and contractual position that the liability has not been ‘incurred jointly’ and that the creditor has no direct claim against the other parties to the joint operation. If the obligor did not recognise this liability in full, it would understate the claims against its assets. The obligor should also consider the accounting for any arrangement under which it receives recompense from the other parties to the joint operation, which could give rise to a separate asset or, if the obligor’s share of assets held jointly is determined by its share of output, a higher share of such assets. It should be noted that these arrangements can be highly complex and varied. Financial statements of the other joint operator(s) The other joint operator(s) in an arrangement of this nature have no liability due to the third party but may be obliged to recompense the obligor by either direct payment or accepting a reduced share of the output of the joint operation. Accordingly, depending on the facts and circumstances, and potentially how the shares of jointly held assets are determined, the arrangement could give rise to either a liability to the obligor (in accordance with the terms of the arrangement for recompensing the obligor) or a lower share of the jointly held assets of the joint operation. As for the obligor, the facts and circumstances of the potentially complex arrangement should be carefully considered.

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Lease obligation in relation to a joint operator’s interest in a joint operation Entity A and Entity B enter into a joint operation that is not structured through a separate vehicle. Entity A enters into a lease contract as the sole signatory with a third-party lessor for an item of property, plant and equipment that will be operated jointly as part of the joint operation’s activities. Entity A has the right to recover a share of the lease costs from the other joint operator, Entity B, in accordance with the contractual arrangement to the joint operation. IFRS 11 requires a joint operator to recognise “its liabilities, including its share of any liabilities incurred jointly” in relation to its interest in a joint operation. Accordingly, Entity A needs to identify and recognise both (a) liabilities it incurs in relation to its interest in the joint operation; and (b) its share of any liabilities incurred jointly with other parties to the joint arrangement. This requires an assessment of the terms and conditions in all contractual agreements that relate to the joint operation, including consideration of the laws pertaining to those agreements. The liabilities a joint operator recognises include those for which it has primary responsibility. Therefore, if under the lease agreement Entity A has primary responsibility to cover the lease payments, Entity A will recognise the full liability for the lease payments. In addition both Entity A and Entity B should account for their rights and obligations that arise from the contractual arrangement to the joint operation applying the principles of IFRS 11. It is noted that both Entities A and Entity B, as the joint operators, need to provide the disclosures required by IFRS 12, i.e. they need to disclose information that enables the users of their financial statements to evaluate the nature, extent and financial effects of its interests in a joint operation, including the nature and effects of its contractual relationship with the other investors with joint control of that joint operation. This conclusion was confirmed by the IFRS Interpretations Committee in the March 2019 IFRIC Update.

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Obligation to purchase output is disproportionate to ownership percentage Two parties enter into a joint arrangement. The arrangement is structured through a separate vehicle. Each party initially subscribes for 50 per cent of the shares in the jointly controlled vehicle. The joint arrangement specifies that the parties are obliged to purchase the output of the arrangement in the ratio 60:40. The parties’ obligations to purchase output are therefore disproportionate to their ownership interests. Consistent with the conclusion in previous example, the joint arrangement is determined to be a joint operation. IFRS 11 does not provide any explicit guidance as to how the joint operators’ ‘share’ of assets held and liabilities incurred jointly should be determined in such circumstances. A joint operator should establish and disclose an accounting policy that treats similar joint operations in a similar manner. In the absence of guidance in IFRS 11, and subject to considering the specific facts and circumstances of the joint operation, the Standard could be interpreted in two ways. Approach 1 – although the joint operators’ obligations to purchase output are a determinant of the classification of a joint arrangement, each party’s share of assets and liabilities is nevertheless established based on its ownership percentage. Applying this approach would result in each party recognising its share of the assets and liabilities either on the basis of (1) its share of dividends and its entitlement on sale, or (2) assuming a liquidation of the joint arrangement vehicle at book value as at the reporting date. Approach 2 – to view the joint operators’ obligations to purchase output not only as a determinant of classification, but also of their proportionate shares of assets held and liabilities incurred jointly. Applying this interpretation would lead to the parties recognising their shares of assets and liabilities based on their output percentages (i.e. the shares of assets they will take and liabilities they will fund on an ongoing basis). When selecting which of the two approaches described above should be applied to a particular joint operation, judgement should be exercised to ensure that the approach adopted results in an appropriate reflection of the economic share of each party in the joint operation. As such, it is important to understand why the share of the output purchased differs from the ownership interest in the joint operation. For example, if the parties contribute only a nominal amount to equity, and they have no rights to accumulated profits (or the arrangement was not designed to generate profits), it might be concluded that the ownership percentage is not a substantive feature of the arrangement (and, therefore, that an approach based on output percentages is more appropriate). If the parties make a substantial investment in the joint operation that differs from their ownership interest, there may be other elements of the arrangements that could explain why there is a difference between the parties’ share of ownership and of output. If other elements of the arrangement are identified, they should be accounted for according to their nature. If, in the example described earlier, the joint operators recognised their shares of assets held and liabilities incurred jointly on the basis of their output percentages (i.e. 60 and 40 per cent, respectively), there will be a difference between the amount of the assets and liabilities initially recognised by the joint operators and their initial contributed equity. Specifically, when the joint arrangement is first established, the net share of assets and liabilities recognised by the joint operator taking the 60 per cent share will be higher than its initial contributed equity; conversely, the share recognised by the joint operator taking the 40 per cent share will be lower than its initial contributed equity. IFRS 11 does not provide any guidance on whether these differences should initially be recognised in profit or loss or as an asset or a liability. Further, it does not provide any guidance on the subsequent accounting for such differences. This issue has been considered by the IFRS Interpretations Committee – see IFRIC Update, March 2015.

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Obtaining an interest in a joint operation that is not a business Two investors (Crude oil company A and petroleum company A) establish a joint arrangement in a general partnership for the exploration and eventual production of oil. The partnership is in the early exploration phase and, as such, holds a single asset – the exploration licence. In addition, crude oil company A notes the following: a. The licence obtained by the partnership has a fair value of C150. b. Crude oil company A contributed cash of C90 for its share in the partnership, and incurred transaction costs of C10. Assume that crude oil company A has analysed the arrangement and determined the following: i. Joint control is clearly established and classification as a joint operation is appropriate. ii. The partnership does not constitute a business under IFRS 3. Question: How does crude oil company A account for obtaining its interest in the partnership? Answer: Crude oil company A would record its 50% interest in the licence as an intangible asset at the cost paid (C100 = contribution + transaction costs). No deferred tax or goodwill would be recognised.

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Obtaining an interest in a joint operation: business combination versus asset acquisition The guiding principle, when accounting for acquisition of an interest in a joint operation, is based on either an asset acquisition or a business combination. The nature of the joint operation and the nature of the interest affect which approach might be applicable. If the joint operation constitutes a business under IFRS 3, the business combination principles are applicable. IFRS 3 cannot be applied to an arrangement that is not a business. In a similar way, an undivided interest in an exploration asset (nature of the interest) requires asset acquisition accounting, even if the assets are expected to be developed into a business in the future. Its revenue from the sale of its share of the output arising from the joint operation. A summary of the two accounting approaches is as follows:   Asset acquisition Business combination Assets and liabilities Consideration paid is allocated to assets acquired, and the investor recognises its share of liabilities assumed Fair value of assets and liabilities acquired (based on investor’s share) Deferred tax IAS 12 initial recognition exemption is available (usually, no deferred tax is recognised) Recognised in accordance with IFRS 3 (can result in substantial amount of deferred tax) Goodwill Not recognised Recognised in accordance with IFRS 3 Contingent liabilities Not recognised, although might impact transaction price and asset valuation Recognised in accordance with IFRS 3 Transaction costs Form part of the cost of the asset Expensed in the period Other All other principles in IFRS 3 are applied, unless considered contradictory to IFRS 11

Examples of the principles on business combinations accounting that do not conflict with the guidance in IFRS 11, and that should be applied when an entity acquires an interest in a joint operation that constitutes a business, are:

• Measure identifiable assets and liabilities at fair value, except for those for which IFRS 3 or other standards provide for an exception.

• Expense any acquisition-related costs, unless the costs relate to the issuance of debt or equity securities. Such costs are recognised under IAS 32 and IFRS 9/IAS 39.
• Recognise deferred tax assets and deferred tax liabilities that arise from the initial recognition of assets or liabilities, except for deferred tax liabilities that arise from the initial recognition of goodwill. Recognise the excess of the consideration transferred over the net of the acquisition date amounts of the identifiable assets acquired and the liabilities assumed as goodwill.

• Test goodwill annually for impairment, as required by IAS 36.

Obtaining joint control of a joint operation: cash payment Entity A pays C200 for a 50% share in a partnership at its formation. Transaction costs of C8 are incurred. The fair value of the identifiable assets and liabilities of the partnership business is C360: Joint control exists, and classification as a joint operation is appropriate. The joint operation constitutes a business under IFRS 3. A partnership does not create legal separation between investors and the arrangement. No prior interest is held in the joint operation. Sample journal entries are as follows: C C Dr Fair value of net assets × 50% (assume deferred tax included) 180 Dr Goodwill 20 Dr Expense – transactions costs 8 Cr Cash 208 Its share of the revenue from the sale of the output by the joint operation.

One party might contribute a business to a joint operation on formation. The party would also apply business combination accounting.

Joint operators might contribute assets to the joint operation, where it is a separate legal entity, on its formation. Where a joint operator contributes assets to the joint arrangement, it is conducting the transaction with the other investors. Where the contribution results in a gain or loss in the joint operator’s books, the gain or loss is recognised only to the extent of the other parties’ interest in the joint operation.

Contribution of asset on formation of a joint operation Entities A and B established a 50/50 joint operation in a separate vehicle, entity J, whereby each operator has a 50% ownership interest and takes 50% of the output. On formation of the joint operation, entity A contributed a property with fair value of C110 and experience of the industry; and entity B contributed equipment with a fair value of C120. The carrying values of the contributed assets were C100 and C80, respectively. Entity A – gain in consolidated financial statements C Entity A’s share of fair value of asset contributed by entity B (50% × C120) 60 Entity A’s share of carrying value of asset contributed by entity A to the joint operation (50% × C100) (50) Gain recognised by entity A 10 This can also be calculated as: Fair value of joint operation gained (50% × C230) 115 Carrying value of asset contributed (100) Unrealised portion of gain (50% × (C110 – C100)) (5) Gain recognised by entity A 10

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Obtaining joint control of a joint operation: contribution of assets Entity A contributes property, plant and equipment, with a fair value of C220 and carrying value of C200, for a 50% share in a partnership at its formation. Transaction costs of C8 are incurred. The fair value of the identifiable assets and liabilities of the partnership business is C360: ·        Joint control exists and classification as a joint operation is appropriate. ·        The joint operation constitutes a business under IFRS 3. ·        A partnership does not create legal separation between investors and the arrangement. ·        No prior interest is held in the joint operation. The journal entries are provided: C C Dr Fair value of net assets × 50% (assume deferred tax included) 180 Dr Goodwill 30 Dr Expense – transactions costs 8 Cr Property, plant and equipment 200 Cr Cash 8 Cr Gain on disposal of property, plant and equipment 10

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Accounting for loss of control transactions that result in joint control The IC discussed whether an entity should remeasure its retained interest in the assets and liabilities of a joint operation when the entity loses control of a business, or an asset or group of assets that is not a business. The IC discussed a potential conflict between the guidance in IFRS 11, which specifies that an entity recognises gains or losses on the sale or contribution of assets to a joint operation only to the extent of the other parties’ interests in the joint operation, and the guidance in IFRS 10, which specifies that an entity remeasures any retained interest when it loses control of the subsidiary. The IASB has recently deferred the effective date of suggested amendments to IFRS 10 and IAS 28, ‘Investments in associates’, and decided to consider a number of related issues at a later date. On this basis, the IC observed that the Post-implementation Review of IFRS 10 and IFRS 11 would provide the Board with an opportunity to consider loss of control transactions and a sale or contribution of assets to an associate or a joint venture. Reporting entities should develop an accounting policy for these transactions and apply it consistently. The policy choice should be disclosed in the financial statements.

A joint operator might increase its interest in a joint operation, in which the activity of the joint operation constitutes a business, by acquiring an additional interest. Previously held interests in the joint operation are not remeasured if the joint operator obtains joint control or retains joint control. Previously held interests in the joint operation are remeasured if the joint operator obtains control.

Obtaining control over a joint operation that meets the definition of a business An entity should apply IFRS 3 where an investor obtains control of a joint operation that constitutes a business. Where the business is contained in a legal entity, the above treatment has been consistently applied in practice. Diversity has been observed where the business is not contained in a legal entity (typically, a joint operation that has been created by contract), because the application of some principles in IFRS 3 becomes problematic. For example, another investor’s retained ownership in the business might not meet the definition of non-controlling interest (for example, the other investor does not have an equity interest, but does maintain an ownership interest). The accounting followed in practice for many of these transactions is, or is a variation of, the following approach: a. Assets/liabilities are recognised at fair value only to the extent of the controlling party’s share. b. Deferred tax and goodwill are recognised relative to the amount of assets and liabilities recognised. c. NCI is not recognised. Any previously held interest is remeasured, whether it is in a separate vehicle or not.

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Changes in levels of ownership whilst retaining joint control: new joint operator in the contractual arrangement Entities A and B are large multi-national oil companies. They constructed a pipeline together in country Z some years ago, which they also operate together. All assets, liabilities, revenues and expenses are shared equally between the parties. The pipeline is a joint operation between entities A and B; both entities A and B account for the pipeline under IAS 16. Due to regulatory changes in country Z, entities A and B must sell a minimum 10% share in the pipeline to a local company, entity C, to be able to keep their operating licence. The selling price is set at an arm’s length level. The joint operators decide that entity A will sell 10% of its share in the pipeline to entity C. Entity A’s share will, therefore, decrease from 50% to 40%. They also modify the agreement’s contractual terms to include entity C in the joint control. The book value of the pipeline is C1,000. The fair value is C1,200. Calculation of gain in entity A’s accounts: C Entity C will pay fair value for its interest (C1,200 × 10%) 120 Entity A would de-recognise 10% of the pipeline at book value (C1,000 × 10%) (100) Gain recognised in both entity A’s separate and consolidated income statement 20

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Obtaining control over a joint operation that does not meet the definition of a business An entity that previously exercised joint control over a joint operation, or was party to a joint operation, might obtain control over the joint operation. An entity might obtain joint control over a joint operation due to a change of interests, where it was previously a party to the joint operation and had rights to the assets and obligations for the liabilities of the joint operations. No remeasurement of the previously held interests should be performed where the above transactions involve a group of assets that do not meet the definition of a business. An entity should apply the asset acquisition method. The consideration paid, together with any direct costs incurred, is recognised on the balance sheet as the cost accumulation of the related assets. In January 2016, the Interpretations Committee noted that paragraph 2(b) of IFRS 3 explains the requirements for accounting for an asset acquisition in which the asset or group of assets does not meet the definition of a business. The Interpretations Committee noted that paragraph 2(b) of IFRS 3 specifies that a cost-based approach should be used in accounting for an asset acquisition; and that, in a cost-based approach, the existing assets are generally not remeasured.

Business combination accounting does not apply on the acquisition of an interest in a joint operation where the parties sharing joint control (including the entity acquiring the interest in the joint operation) are under the common control of the same ultimate controlling party or parties both before and after the acquisition, and that control is not transitory.

Accounting by a joint operator for a lease with a joint operation – example In some cases, an entity that jointly controls an asset, such as real estate, through a joint operation may enter into an agreement to rent a portion of that asset for its own use. For example, Entity A and Entity B are joint operators of a joint operation involving an office building. Entity A and Entity B each have a 50 per cent undivided co-ownership interest in the building, which is not held in a separate legal entity. As a result of the undivided co-ownership, the entirety of the office building is jointly owned by Entity A and Entity B and neither party has exclusive rights to any part of the building. At the inception of the joint operation, Entity A enters into a rental agreement with the joint operation to obtain the exclusive right to use 12 floors of the 30-floor building (i.e. 40 per cent of the space) for 10 years. The rental agreement provides Entity A with the right to control the use of the 12 floors for the 10-year term. The life of both the building and the joint operation arrangement is well beyond 10 years. The remaining floors are rented to third parties. Entity A and Entity B share equally in all of the rental income from the building and in all of the expenses. From the perspective of the joint operation, the building qualifies as investment property as defined in IAS 40 and the rental agreements with the third parties qualify as operating leases under IFRS 16. Identifying whether the rental agreement constitutes a lease Entity A should evaluate whether the rental agreement with the joint operation constitutes a lease. IFRS 16 indicates that a lease exists if the contract conveys the right to control the use of an identified asset for a period of time in exchange for consideration. The 12 floors represent an identifiable asset that is physically distinct from the rest of the building. Without the rental agreement Entity A does not control the 12 floors and instead those floors would be jointly controlled with Entity B. However, the rental agreement provides Entity A with the ability to control the use of those 12 floors for the 10-year term. As such, the arrangement between Entity A and the joint operation to use the 12 floors constitutes a lease, as defined in IFRS 16. The requirement for Entity A to evaluate whether the rental contract is a lease is consistent with the fact that contracts between a joint operator and a joint operation are not scoped out of IFRS 16. IFRS 16 contemplates a situation where an entity provides goods or services to a joint arrangement (i.e. the joint arrangement is the customer) and concludes that an assessment should be made to determine whether the contract constitutes a lease by determining whether the joint arrangement has the right to control the use of an identified asset throughout the period of use. It would appear reasonable that a similar assessment be undertaken when the joint arrangement is the supplier. In this case, the joint arrangement is the supplier of property rental services. Accounting by Entity A for the lease with the joint operation IFRS 11 requires that a joint operator recognises, in relation to its interest in a joint operation, its assets, including its share of any assets held jointly, and its liabilities, including its share of any liabilities incurred jointly. In addition, IFRS 11 requires that a joint operator accounts for the assets and liabilities relating to its interest in a joint operation “in accordance with the IFRSs applicable to the particular assets and liabilities”. For example, if a joint operator has a lease with the joint operation, it would apply IFRS 16 in accounting for that lease. To illustrate the accounting by Entity A, consider the following additional facts. At the inception of the joint operation, Entity A and Entity B each contribute CU100 in cash to finance the acquisition of the building, which has a fair value of CU200. All of the leases for occupancy of the building are operating leases. The statement of financial position of the joint operation at inception is as follows: CU Investment property 200 Total assets 200 Equity 200 Total equity 200 At the inception of the joint operation, Entity A records the following accounting entries. Entity A’s 50 per cent interest in the joint operation’s assets. CU CU Dr Investment property 100 Cr Cash 100 When Entity A enters into the rental agreement with the joint operation, of which it is a 50 per cent joint operator, in effect it is entering into an agreement with itself (in respect of 50 per cent of the rental agreement) and with Entity B (in respect of 50 per cent of the rental agreement). Considering that Entity A is renting 40 per cent of the building, in effect in respect of 20 per cent of the building it is both lessee and lessor, and for the remaining 20 per cent it is lessee with Entity B as lessor. With respect to the portion for which it is both lessee and lessor, Entity A recognises neither a right-of-use asset nor a lease liability (applying the principles in IFRS 11 for accounting for purchases from a joint operation, Entity A does not recognise a liability owing to itself). However, in accordance with IAS 40, it transfers the corresponding portion of the building from investment property to property, plant and equipment. CU CU Dr Property, plant and equipment 40 Cr Investment property 40 With respect to the 20 per cent it leases from Entity B, Entity A recognises a right-of-use asset and lease liability which represents Entity A’s obligation to the other joint operator for its use of the property owned by the other joint operator. CU CU Dr Right-of-use assets X Cr Lease liability X In effect, the right-of-use asset and lease liability is 50 per cent (Entity B’s ownership interest) of the present value of the lease payments which Entity A is required to make over the lease term in accordance with IFRS 16. To summarise, at inception of the joint operation Entity A recognises: the portion of the building which it owns and occupies as property, plant and equipment; the portion of the building which it owns and is occupied by third parties as investment property; and a right-of-use asset and lease liability for the portion of the property which it leases from the other joint operator.

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Remeasurement gain or loss on a retained interest in a joint operation that was formerly a subsidiary Upon loss of control of a subsidiary, IFRS 10 requires a parent to derecognise the assets and liabilities of the subsidiary (including non-controlling interests) and measure any investment retained in the former subsidiary at its fair value. The remeasurement gain or loss forms part of the total gain or loss on the disposal of the subsidiary and is recognised in profit or loss. In contrast, when an entity contributes assets to a joint operation in which it is a joint operator, IFRS 11 limits the gain or loss recognised “to the extent of the other parties’ interests in the joint operation”. A question arises as to whether an entity that loses control of a subsidiary, but retains an interest in a joint operation, should limit the gain or loss to be recognised to the extent of the other parties’ interest in the joint operation. In July 2016, the IFRS Interpretations Committee (Committee) discussed whether an entity should remeasure its retained interest in the assets and liabilities of a joint operation when the entity loses control of a business, or an asset or group of assets that is not a business. In the transaction discussed, the entity either retains joint control of a joint operation or is a party to a joint operation (with rights to assets and obligations for liabilities) after the transaction. The Committee noted that IFRS 11 specify that an entity recognises gains or losses on the sale or contribution of assets to a joint operation only to the extent of the other parties’ interests in the joint operation. The requirements in these paragraphs could be viewed as conflicting with the requirements in IFRS 10, which specify that an entity remeasures to fair value any retained interest when it loses control of a subsidiary. The Committee observed that the Board issued amendments to IFRS 10 and IAS 28 in September 2014 to address the accounting for the sale or contribution of assets to an associate or a joint venture. Following finalisation of the September 2014 amendments, the Board identified several practical issues affecting the implementation of the amendments. As a result, the Board deferred the effective date of the September 2014 amendments pending finalisation of a larger research project on equity accounting. Because of the similarity between the transaction discussed by the Committee and a sale or contribution of assets to an associate or a joint venture, the Committee concluded that the accounting for the two transactions should be considered concurrently by the Board. Consequently, the Committee decided not to add this issue to its agenda but, instead, to recommend that the Board considers the issue at the same time the Board further considers the accounting for the sale or contribution of assets to an associate or a joint venture. Therefore, in the absence of further guidance, when an entity loses control over a subsidiary that constitutes a business but retains an interest in a joint operation (e.g. as a result of a sale or contribution of the subsidiary to a joint operation in which it is a joint operator), entities should make an accounting policy choice and apply either: the approach in IFRS 10 — the retained interest in the assets and liabilities of the former subsidiary is remeasured and the gain or loss on remeasurement is recognised in full in profit or loss; or the approach in IFRS 11 — the retained interest in the assets and liabilities of the former subsidiary is not remeasured such that the gain or loss recognised in profit or loss on the transaction is limited to the extent of the other parties’ interests in the joint operation. However, when the operations of the subsidiary do not constitute a business such that the substance of the transaction is that of a contribution or sale of asset(s) to a joint operation in which the entity is a joint operator, IFRS 11 is directly relevant and the entity should recognise gains and losses only to the extent of the other parties’ interest in the joint operation.

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Remeasurement gain or loss on a retained interest in a joint operation that was formerly a subsidiary – a contribution of a subsidiary which is in substance an asset – example Entity A contributes Subsidiary B, whose only asset is a mine, to a joint operation. Entity A has concluded that Subsidiary B is not a business. In exchange for its contribution, Entity A obtains a 40 per cent interest in the joint operation. Before the transaction, the carrying amount of the mine is CU1,000 in Entity A’s consolidated financial statements. The fair value of the contributed subsidiary (and of the mine) is CU1,200 which is equal to the fair value of its 40 per cent interest in the joint operation. Other investors contribute CU1,800 in cash to obtain a 60 per cent interest in the joint operation. All investors hold a proportionate share in the mine held by the joint operation. The joint operation has no other assets apart from the cash and the mine, and has no liabilities. IFRS 11 requires Entity A to recognise a gain only to the extent of other parties’ interest because, in substance, the transaction is the transfer of an asset to a joint operation. Consequently, the gain recognised in the consolidated financial statements of Entity A on disposal of Subsidiary B is limited to CU120.     Carrying amount of the interest in the mine effectively transferred to the other investor 600 (60% × 1,000) Cash received from the other investors 720 (40% × 1,800) Gain on the transaction 120 Therefore, the accounting entry required by Entity A in its consolidated financial statements is as follows:     CU CU Dr Cash (share of cash in joint operation – CU1,800 × 40%) 720 Dr Retained interest in mine (CU1,000 × 40%) 400 Cr Mine transferred to the joint operation 1,000 Cr Gain on contribution 120

Subsequent measurement

Where the entity is involved in a joint operation, the investors account for their rights and obligations by recognising:

“a. its assets, including its share of any assets held jointly;

1. its liabilities, including its share of any liabilities incurred jointly;

1. its revenue from the sale of its share of the output arising from the joint operation;

1. its share of the revenue from the sale of the output by the joint operation; and e. its expenses, including its share of any expenses incurred jointly.”

Non-coterminous year ends There is no guidance in IFRS 11 for joint operators that prepare financial statements at different year ends from their joint operations. In our view, the principles of IAS 28 for joint ventures should be followed. Therefore, the joint operation’s financial statements used for the purpose of including results in the investor’s financial statements should preferably be coterminous with those of the investor. Where the joint operation prepares its annual financial statements to a different year end, it would need to prepare special purpose financial statements to the same date as the joint operator’s year end. Where the preparation of special purpose financial statements coterminous with its investor is not practicable, the joint operation’s own financial statements can be used if they are made up to a date that is not more than three months before or three months after the investor’s period end. Where the reporting period of the joint operation’s financial statements does not coincide with that of the investor, management should establish whether there are any significant transactions or events that have occurred between the reporting dates. Where such events have taken place and the effect is material, management should make adjustments to the financial statements of the joint operation before it is accounted for within the joint operator’s consolidated financial statements. Adjustments of this nature might be required for dividends paid by the joint arrangement to the investor and for the settlement of inter-company balances. Other significant events occurring between the joint arrangement’s reporting date and the investor’s reporting date might also need to be adjusted. We believe that the joint operator should disclose the date of the end of the reporting period of the joint operation’s financial statements, and the reason for using a different date or period.

The operator treats the operations as if it conducted them directly. The accounting entries are booked in the joint operator’s own financial statements.

Accounting in separate financial statements of the joint operator The joint operator is required to account for its rights and obligations in relation to the joint operation. Those rights and obligations are the same, whether separate or consolidated financial statements are prepared. Therefore, the same accounting is required in the consolidated financial statements and in the separate financial statements of the joint operator. In March 2015, the Interpretations Committee observed that the joint operator would not additionally account in its separate or consolidated financial statements for its shareholding in a joint operation in a separate vehicle; this is because it is required to account for the activity of the joint operation within its own financial statements.

Management should classify and measure the recognised asset, liability and items of revenue or expense, or the share of an asset, liability or item of revenue or expense, according to the applicable standard for each item. For example, if a joint operator recognises an item, or a share of an item of property, plant and equipment, it accounts for its measurement and de-recognition in accordance with IAS 16; it should also apply the provisions of IAS 36 for impairment purposes.

Where a joint operator has an interest in a joint asset, it recognises the underlying asset directly rather than recognising a separate intangible representing the right to the underlying asset. For example, if a pipeline is operated by a number of oil and gas businesses in a certain country, the investor recognises its share of the pipeline. The share to be accounted for is determined by the contractual agreement between the operators that governs the joint arrangement. The pipeline is classified as property, plant and equipment on the operator’s balance sheet.

Joint operation accounting: loan transactions with joint operation Entities A and B have entered into a joint arrangement to develop products. They agree the joint arrangement’s strategy. Entity A, which builds the product, manages the day-to-day production. It makes a 10% margin on the products that it sells to the joint operation. Entity B identified the opportunity and provided C40 investment capital. Entity A provided C10 investment capital. Profits are shared 50/50. The joint operation took out a loan of C100; the interest charge for the year on this loan is C8. Entity A incurred costs of C70 for work in progress in the first year; C50 of this was charged to the joint operation at a price of C55. The joint operation made sales of C40 to third parties, and the cost of the sales in the joint operation was C30. There are no third-party receivables or payables at the year-end, because all transactions have been settled. Entity A’s consolidation workings are as follows: Entity A JO 50% of JO Adjustments Entity A adjusted Balance sheet Investment 10.0 – – (10.0) (e) – Inventory, analysed: 20.0 25.0 12.5 (1.14) (c) 31.36 Costs 70.0 55.0 27.5 (12.5) (a) 85.0 Adjustment to cost of sales (50.0) (30.0) (15.0) 11.36 (b) (53.64) Cash 5.0 127.0 63.5 0 68.5 Total assets 35.0 152.0 76.0 (11.14) 99.86 Borrowings 30.0 100.0 50. 0 80.0 Liability to joint operators – 50.0 25.0 (10.0) (d) 15.0 Equity – Retained earnings 5.0 2.0 1.0 (1.14) (c) 4.86 Total equity and liabilities 35.0 152.0 76.0 (11.14) 99.86 Income statement Revenue 55.0 40.0 20.0 (12.5) (a) 62.5 Cost of sales (50.0) (30.0) (15.0) 11.36 (b) (53.64) Gross profit 5.0 10.0 5.0 (1.14) (c) 8.86 Finance cost – (8.0) (4.0) 0 (4.0)   Profit after tax 5.0 2.0 1.0 (1.14) 4.86 Notes: (a) Half of entity A’s sales have, in effect, been made to entity B. Entity A can continue to recognise these (50% × C55 = C27.5). Entity A can recognise profits arising from the sales between entity A and the joint operation only when these are realised (that is, sold to third parties). The joint operation has not sold inventory worth C25 to third parties, because this is still recorded in the balance sheet (see ‘Inventory’ line in table above). (b) Half of entity A’s cost of sales relates to sales made, in effect, to entity B. The other half (that is, C25) relates to the goods sold to the joint operation at a profit margin of 10%. The unsold portion of this needs to be eliminated (that is, C25 × 25/55 = C11.36). The elimination follows the need to eliminate the unrealised profit, as explained in (a) above. Any unrealised portion of the C27.5 of entity A’s revenue – that is, the C25 of inventory not yet sold – needs to be eliminated (that is, C27.5 × 25/55 = C12.5). (c) The total adjustment to inventory and gross profit is therefore the net of the adjustment to revenue and cost of sales (that is, C12.50 – C11.36 = C1.14). We need to eliminate the gross profit recognised by entity A for the inventory that the joint operation has not yet sold. The cost of sales of the inventory remaining at the year-end is C50 × 25/55 = C22.72. Therefore, the gross profit on this element is C2.28 (that is, C25 – C22.72). Of the gross profit of C2.28, entity A must eliminate its share, which is C1.14. (d) There is a disparity in the amount of capital contributed by both of the parties to the joint operation. Entity A has contributed 20% of the monetary capital, compared to the 80% contributed by entity B. If entities A and B decide to dismantle the joint operation, entity A would have to pay C15 to entity B, to reflect the fact that it has recognised 50% of the monetary capital in its accounts, whereas it has only contributed 20%. As the joint operation progresses, entity B’s capital is likely to be repaid out of the joint operation’s cash resources, which will settle this obligation. (e) The investment in the joint operation is eliminated on consolidation.

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Accounting for joint operations: treatment of intra-group balances: ring-fencing In a 50/50 joint operation, one investor (investor A) provides a loan of C100 to the joint operation. Effectively, half of that loan has been made to the other investor (investor B). Investor B also shares in half of the cash borrowed by the operation. Therefore, investor A records a reduction in cash of C50 (C100 advanced, reduced by the C50 share from the joint operation) and a loan receivable. Investor B records an increase in cash of C50 and a liability.   Investor A JO Share Adjustment Total Loan receivable from JO 100 – – (50) 50 Cash – 100 50 – 50 Borrowings (100) (50) 50 – Investor B JO Share Adjustment Total Loan receivable from JO – – – – – – Cash – 100 50 – 50 – 100 50 – 50 Borrowings – – (100) (50) – (50) An alternative rationale is that the joint operation has C25 of inventory that it has not yet sold, of which 50% (that is, C12.5) belongs to entity A, and so it should not be recognised within entity A’s sales. If investor B provides a similar loan, both investors will again apply this accounting, resulting in each recognising a receivable of C50 and a liability of C50 and no net change in cash, since investor A has contributed C50 but has recognised its share of cash held in the joint operation of C50 (C100 × 50%). Depending on the governance structure, given that each investor has only joint control, it is unlikely that either investor would have the ‘legally enforceable right to set off the amounts’ which would be required to achieve the offset of the asset and liability under IAS 32. However, if the loan made by each investor was repayable only out of its own share of the assets, and the debt proceeds in the operation were ringfenced for the benefit of that investor, that investor would not have conducted a transaction with the other parties to the joint operation. Instead, these balances eliminate when each investor prepares its consolidated accounts. An operator cannot have a payable balance due to itself.   Investor A JO Share (ringfenced share) Adjustment Total Loan receivable from JO 100 – – (100) – Cash 100 100 – 100 Borrowings (100) (100) 100 –

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Vehicle with legal separation: accounting for joint operations The first step in joint operation measurement is to determine what should be measured This determination is more complicated where the joint operation is contained in a vehicle that creates legal separation (for example, in a limited liability company). A joint arrangement in a separate vehicle can be a joint operation where the legal form has been superseded either by contractual terms between the investors or an assessment of ‘other facts and circumstances. In either case, determination of ‘what to measure’ can be complicated. Legal form superseded by contractual rights We would expect contracts in these cases to contain sufficient detail to specify which investor has direct rights to a particular asset and/or an obligation for a particular liability. However, investors might lack clarity on ‘their share’ for any item that is not specified by the contracts. Legal form superseded by ‘other facts and circumstances’ Significant judgement might be needed to provide a faithful representation of the arrangement and the underlying economics where an arrangement is classified as a joint operation because of ‘other facts and circumstances. This is most relevant where the share of output differs from the share of ownership. Companies might define ‘share’ based on all of the following (to the extent that they are not specified in a contract or legal arrangement): ·        Amount of output taken (typically, as a percentage). ·        Ownership percentage. ·        Voting percentage (if different from ownership). ·        Distribution of revenue or profits (if contractually defined differently from the other percentages above). Some situations might even be represented best by a combination of the items above, due to contractual terms – for example, revenue/expenses split based on contractual agreement, and share of assets and liabilities default to ownership percentage. Judgement should be applied consistently to all similar transactions. Similar outcomes should be reached for similar fact patterns.

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Vehicle with legal separation: investors obliged to take all of the output Automotive supplier A and automotive supplier B are two automotive suppliers that specialise in braking components for motor vehicles (such as rotors and pads). They each contribute cash to a new, jointly controlled LLC that makes custom brake pads. The arrangement enables them to combine technologies and to achieve economies of scale that they would not have achieved separately. The arrangement is classified as a joint operation, because the shareholder agreement requires the investors to take 100% of the output at an estimated market price. Specifically, it requires automotive supplier A to take 60% and automotive supplier B to take 40% of the annual production. Profits are split based on ownership level (50/50). Automotive supplier A and automotive supplier B agreed to take all of the output, because they each have robust distribution networks that can be leveraged effectively without creating a new process in the LLC. They each contributed the same level of initial capital. They agree to take disproportionate shares of output, based on their current distribution networks; however, the split of output can be adjusted each year. All purchases are made at an estimated market price, creating market-based returns for the LLC. Question: What is automotive supplier A’s share of the joint operation? Answer: Management needs to consider why a difference between ownership interest and output level exists, when determining share: 1. Why are the investors required to take all of the output? Because they each have robust distribution networks that can be leveraged effectively without creating a new process in the LLC. 2. Did one investor contribute more initial capital or assets than the other? No. 3. Does the split of output taken change over time? Yes. It can be adjusted each year. The facts indicate that each party has a 50/50 share of the arrangement (ownership and economics appear to be shared evenly).

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Accounting treatment where all of the output is taken by joint operators Joint operators would not recognise any amount for the sale of output by the joint operation to other joint operators. If all of the output is taken by the parties and there is a joint operation, the joint operators only recognise revenue when they sell their output to third parties. Two parties, A and B, form a company to build and use a pipeline to transport gas. Party A has a 40% ownership interest, and party B has a 60% ownership interest in the company. The arrangement is classified as a joint operation, because the shareholder agreement requires the investors to take 100% of the output at a cost-plus price. In this scenario, neither party would recognise its share of revenue from the sale of output by the joint operation; to do so would mean that it would be recognising revenue from output sold to itself. Parties A and B would only recognise revenue when they sell their share of output taken from the joint operation to a third party.

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Accounting treatment where share of output purchased differs from ownership interest Two parties, A and B, form a company to build and use a pipeline to transport gas. Party A has a 40% ownership interest, and party B has a 60% ownership interest in the company. Parties A and B must each use 50% of the pipeline capacity. This share of output differs from the share of ownership interest. Joint operators might make a substantial investment in the joint operation that differs from their ownership interest. This could indicate that there are other elements or agreements in place. The identification of these other elements might provide relevant information to determine how to account for the difference between ownership interest and share of output. Some questions to consider, in understanding this disconnect between the ownership interest and share of output, include: ·        Why are the parties required to take all of the output? ·        Has one party contributed more initial capital or assets than the other? ·        Does the split of output taken change over time and, if so, why? The contractual requirement for the parties to purchase all of the output at a price covering the costs of the arrangement provides rights to the underlying assets and obligations for the liabilities of the arrangement. This determined classification as a joint operation. Party A initially contributed less equity than party B. In this case, party A’s share of the joint operation is partly funded, in substance, by party B. The contractual terms require party A to settle the difference arising between the capacity interest taken and the ownership interest on liquidation of the arrangement. Therefore, the parties account for the operation based on their share of the output, or pipeline capacity. Party A accounts for its share of assets and liabilities at 50%. The difference that arises between this and the equity that party A contributed to the joint operation of 40% represents a payable to party B. Party B would also recognise its share of assets and liabilities of the joint operation at 50%. The difference from the 60% that it contributed is a receivable from party A. Party A will pay back this source of financing to party B on liquidation of the arrangement.

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Accounting by the operator in a joint operation Joint operations are common in the oil and gas industry. Parties to a joint operation, not structured in a separate vehicle, often appoint one of the joint operators as the ‘operator’. The structures usually have the following characteristics: The operator is assigned with the responsibility of entering into contracts with various parties. The shareholders’ agreement between the joint operators normally specifies that the operator is reimbursed by the other joint operators for any expenditure incurred on behalf of the joint arrangement. An operator might sign an explicit or implicit lease on behalf of its partners, and the operator might be the primary obligor with the owner of the asset. For example, a 30% partner that is the operator of a field might sign an exclusive processing agreement with the owner of a gas-processing facility. The operator might be liable for 100% of the processing payments and entitled to recover 70% of those payments from its partners. A joint arrangement, or a party acting on behalf of the joint arrangement, could be the lessee in a lease under IFRS 16 (there was no equivalent guidance under IAS 17). The question that arises is how to account for the lease in the financial statements of the operator and of the other joint operators. IFRS 11 requires the joint operators to recognise assets and liabilities based on the contractual arrangements. A joint operator will need to recognise its assets and liabilities, including its share of assets held jointly. In a situation where a joint operator enters into a lease with a third party on behalf of a joint operation, the joint operator should recognise the obligation for payments to the third-party lessor for which it is solely responsible under the lease agreement. The operator that enters the lease with the third party will often be solely responsible for all of the payments under the lease agreement and will therefore recognise the entire lease liability. The entity should assess whether it has transferred control of the leased asset to the joint arrangement or whether it maintains control of the leased asset. If control is transferred, the joint operator that leased the asset may account for the transfer of the right of use asset as a sublease under IFRS 16. If control of the leased asset is maintained by the operator that entered into the lease, the accounting should be similar to when a joint operator uses owned PP&E in the activities of the joint operation and receives reimbursement from the other joint operators. In this situation, the joint operator that entered into the third-party lease will generally account for the reimbursements it is entitled to under the joint operating agreement on an accrual basis. The contractual agreements might provide additional clauses that would impact the accounting. For example, where all of the parties to the joint operation are parties to the lease agreement and have joint and several liability for the lease payments, it might be more appropriate that the joint operators recognise their share of right of use asset and liability. There is a substantive difference between a transaction in which all parties collectively enter into a lease agreement for which they are jointly and severally liable and a transaction in which one joint operator enters into both a lease agreement as the sole signatory with a third party and a separate agreement to be reimbursed by the other parties to the joint operation.

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Output received differs from entitled output Question: Entity A and Entity B jointly control a producing oil and gas property. Entity A has a 70% interest and Entity B a 30% interest. Under the agreement, each entity is required to reimburse the joint operation for its share of costs incurred by the joint operation and is entitled to receive oil produced by the joint operation commensurate with its ownership interest. During the period, the joint operation produced 1,000 barrels of oil for which Entity A was entitled to 700 barrels and Entity B was entitled to 300 barrels. For operational reasons, Entity B ‘over lifted’ 50 barrels of oil (for example. it received 50 barrels more oil more than it was entitled to receive under the joint operating agreement). Entity A ‘under lifted’ and received 50 barrels less than it was entitled to but paid its 70% of costs commensurate with its 70% interest. Accordingly, Entity A received and sold 650 barrels and Entity B received and sold 350 barrels. Under the joint operating agreement, any imbalance of output received is to be physically settled in a subsequent period and neither entity has an option to settle the imbalance in cash (i.e., even in the eventuality where no further production occurs the over lift must be physically settled). Assume market price of oil during the period was CU 100 per barrel and this was the price that each operator sold its oil to customers when received. As soon as each entity receives its output from the joint operation, it delivers the oil to a customer at market price. How should each joint operator account for this imbalance? Answer: In the fact pattern described, each entity should only recognise IFRS 15 revenue upon sale to its customer. This is consistent to what was historically referred to as the ‘sales approach’ which was used by some entities prior to the adoption of IFRS 15. Accordingly, Entity A would recognise revenue of CU 65,000 (650 barrels X CU 100) and Entity B would recognise revenue of CU 35,000 (350 barrels X CU 100). Generally, depletion of oil and gas assets is based on ‘units of production.’ Deferral of the depletion costs by the under lifter may be accomplished through reducing the units of production depletion charge (i.e., to reflect that the under lifter is entitled to more than its share of production in the future). Over lift/under lift arrangements may allow for settlement in cash in certain circumstances, even if this is not the expected manner of settlement. If the joint operation agreement allows for cash settlement of the imbalance in any circumstance, an entity would need to assess whether it was appropriate to recognise a financial asset or liability in the scope of IFRS 9. Such an asset or liability arises from a transaction with the other joint operator or operators and it would generally not be appropriate to record the transaction as revenues from contracts with customers. However, an under lifting entity may record a credit to “other revenues” if it recognizes a financial asset due from the other joint operator.

Upstream transactions

Joint operators might also enter into ‘upstream transactions’ with an operation − that is, where the asset is sold by the joint operation to the joint operator. The joint operator’s financial statements should defer any resulting gain or loss in an upstream transaction until the joint operator sells the asset to a third party.

Any impairment charge should be recognised immediately in the joint operator’s income statement, where such transactions provide evidence of a reduction in the net realisable value of the assets.

Upstream transaction: sale of inventory Entities A and B established a 50/50 joint operation in a separate vehicle, entity J, in which each of them has a 50% ownership interest. Entity J exclusively sells all of its inventory to its investors, with each taking 50%. As at 31 December 20X1, entity A has inventory of C100 from entity J on its balance sheet. The cost in entity J’s books for this inventory is C60. Entity J recognised a profit of C40 in relation to the above transaction, which is unrealised in entity A’s accounts because the inventory is unsold at the year end. The unrealised profit should be eliminated against the inventory value (that is, the closing carrying value is reduced to C60). The profit is unrealised until entity A itself sells the inventory.

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Intra-group transaction Entities A and B have entered into a joint operation structured through a separate vehicle. Each operator has a 50% interest in the joint operation entity (JOE). There are no third-party sales from the JOE itself. The JOE sells all of the output to the joint operators, with each taking 50%. In 20X2, the total revenue of the JOE from sales to the two operators was C1,000 (C500 to each operator). Total cost of sales of the JOE is C800. As of 31 December 20X2, entity A has sold the output acquired from the JOE to third parties for C550, with a mark-up of 10%. The receivables of the JOE against entity A, and the liability of entity A against the JOE, are settled as of 31 December 20X2. As of 31 December 20X2, the JOE’s only asset is cash of C1,000, and it has no liabilities. Question: Which part of the revenue from the JOE should be eliminated by the joint operators (entities A and B) when accounting for the joint operation? Answer: Entity A has to recognise its share of the revenues and expenses in relation to its interest in the JOE. Entity A’s interest in the revenues and expenses of the JOE is the revenues of C500 directly generated from the sale of the output to entity A and the corresponding cost of sales of C400. The sales are revenues of the JOE, generated with entity A itself. Entity A has to eliminate these revenues in full, as part of its consolidation procedures. Not eliminating the revenues in full would result in a form of double counting of revenues. Recognising its share of the income and expenses of the JOE, entity A would account for cash of C500, revenues of C500 and cost of sales of C400, corresponding to its 50% interest in the JOE. The elimination is as follows:   JOE Entity A’s share in JOE (50%) Entity A Elimination Consolidated results   (C) (C) (C) (C) (C) Revenue 1,000 500 550 (500) 550 Cost of sales (800) (400) (500) 500 (400) Entity A would recognise, in its consolidated financial statements, the revenues from third parties of C550 and cost of sales of C400.

Downstream transactions

Joint operators might contribute assets to the joint operation where it is a separate legal entity, or might sell assets to the joint operation (‘downstream transactions’). Where a joint operator contributes assets to, or enters into a sale agreement with, the joint operation, it is conducting the transaction with the other investors. Where the contribution results in a gain or loss in the joint operator’s books, the gain or loss is recognised only to the extent of the other parties’ interest in the joint operation. There is no accounting impact where a joint operator uses its own assets in the joint operation and retains full ownership and control of these assets. The joint operator retains its assets and liabilities on the balance sheet.

The investor must recognise any impairment charge in its books if the transaction provides evidence of an existing impairment. It is presumed that the asset was already impaired before the sale to the joint operation.

Accounting for an asset contributed to a joint operation to which other operators become entitled Question: How should the joint operators account for an asset contributed to a joint operation to which other operators become entitled? Answer: Where the other operators become entitled to an interest in an asset contributed to a joint operation, the joint operator de-recognises the relevant proportion of the asset and recognises a gain or loss for the difference between the amount de-recognised and the fair value of any consideration received. The other operator recognises its share of the fair value of the assets of the other operators to which it becomes entitled.

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Contribution of impaired asset on formation of a joint operation Entities A and B established a 50/50 joint operation in a separate vehicle, entity J, whereby each operator has a 50% ownership interest and takes 50% of the output. On formation of the joint operation, entity A contributed a property with fair value of C110 and experience of the industry; and entity B contributed equipment with a fair value of C120. The carrying values of the contributed assets were C130 and C80, respectively. Entity A – impairment in consolidated financial statements C Fair value of joint operation gained (50% × C230) 115 Carrying value of asset contributed (130) Loss recognised by entity A (15) The C15 loss is the full impairment of C20 (being the difference between the fair value and carrying value of A’s property) and a recognised gain of C5 (being the difference between the fair values of C115 and C110).

B. Joint venturers

A joint venturer uses the equity method to account for its investment in a joint venture. Equity accounting is covered in IAS 28.

IAS 28 specifies the following scope exemptions from applying the equity method of accounting:

• Exemption from the preparation of consolidated financial statements.
• Venture capital organisation.
• Classification as held for sale.

Initial recognition

On initial recognition, the investment in joint venture is recognised at cost. Cost could be the purchase price, contingent consideration and acquisition costs.

Cost is “the amount of cash or cash equivalents paid or the fair value of the other consideration given to acquire an asset at the time of its acquisition or construction, or, when applicable, the amount attributed to that asset when initially recognised in accordance with the specific requirements of other IFRSs, e.g., IFRS 2”.

An investor will need to perform an exercise similar to ‘acquisition accounting’ when acquiring an investment in an associate. Where the cost exceeds the share of the net fair value of the joint venture’s identifiable assets and liabilities, the difference is accounted for as notional goodwill. The goodwill is included in the carrying amount of the investment. Where the cost is less than entity’s share of the net fair value of the investee’s identifiable assets and liabilities, the difference is included in profit or loss as part of the entity’s share of the joint venture’s profit or loss in the period of the acquisition (‘negative goodwill’).

The investor might designate loans receivable or other financial assets as part of the net investment in a joint venture. Such longterm interests are accounted for in accordance with IFRS 9 (IAS 39).

Joint venturers often invest in joint ventures by contributing or selling non-monetary assets to the joint venture. This results in a venturer acquiring an interest in the joint venture at the same time as it disposes of an asset or business.

Accounting for a joint operation structured through a separate vehicle in the separate financial statements of a joint operator The IFRS Interpretations Committee has considered the appropriate accounting by a joint operator in its separate financial statements for its share of assets and liabilities of a joint operation when that joint operation is structured through a separate vehicle (see IFRIC Update, March 2015). The joint operator should account for its interest in the joint operation in its separate financial statements by recognising its share of the assets, liabilities, revenue and expenses of the joint operation in the same way as is required by IFRS 11 for the consolidated financial statements of joint operators. The joint operator should not additionally account in its separate or consolidated financial statements for its shareholding in the separate vehicle (whether at cost, at fair value, or using the equity method).

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Formation of a joint venture: difference between assets contributed between two parties Question: How should an entity account for any difference between the fair value of business contributed and the fair value of the assets contributed by the other venturers? Answer: Management should account for the joint venture initially at the fair value of the contributed assets or business (including any related goodwill). Where the fair value of the assets or business contributed is in excess of the venturer’s share of the fair value of the assets contributed by the other venturers, the excess is goodwill (in effect, a comparison is made to the fair value of what the other venturer has contributed in setting up the joint venture). The venturer does not revalue its interest in its own assets contributed to the joint venture. Any goodwill recognised in such a way is only notional, and it is not recognised as a separate asset on the venturer’s balance sheet. The joint venture does not necessarily recognise any fair value adjustments identified by the joint venturer in the carrying amounts of its assets and liabilities. When equity accounting its interest in the joint venture, the joint venturer will need to adjust the results of the joint venture to take into account the impact of any notional fair value adjustments. IFRS 10 indicates that, on loss of control of a subsidiary, any retained interest should be remeasured to its fair value, with any resulting gain or loss recognised in the income statement. A gain or loss is therefore recognised on the portion retained, in addition to the gain or loss on the portion no longer owned. Entities should adopt a policy and consistently apply either IAS 28 or IFRS 10 when dealing with contributions of a subsidiary to a joint venture. In September 2014, the IASB issued an amendment to address this inconsistency. The amendment effective date was deferred indefinitely in December 2015.

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Venturer transfers a business to a joint venture in exchange for equity interest: accounting policy under IAS 28 Entity A enters into a joint venture with entity B. Their relative interests in the joint arrangement are 60% and 40% respectively. The joint venturers agree to contribute businesses, which are held in subsidiaries and transferred as a share transfer, as follows: ·        Entity A held its investment in the subsidiary that contained the business at C200 (comprising C100 of net identifiable assets and C100 of goodwill), and the fair value of the business is C300. In its separate financial statements, entity A held its investment in the subsidiary that contained the business at a cost of C200. ·        Entity B held its investment in the subsidiary containing the business at C150 (comprising net identifiable assets with a book value of C100 and goodwill of C50), and the fair value of the business is C200. The fair value of the joint arrangement’s total net identifiable assets is C270, which comprises the fair value of the net identifiable assets of entity A of C150 and entity B of C120. The fair value of the joint venture’s business is C500. Entity A’s accounting policy is to follow the IAS 28 rules, and so it eliminates gains/losses on downstream transactions to the extent of the other investor’s share. The cost of each venturer’s investment in the joint venture should be compared with that venturer’s share of the fair value of the net identifiable assets contributed by the other venturer. The excess of the cost of investment over the net assets’ fair value represents goodwill. The cost of each venturer’s investment is the fair value of the consideration given, being the fair value of what each venturer has contributed. In this example, this will be the business contributed, which will include not only the assets contributed but also the associated goodwill. Entities A and B have each contributed a proportion of their existing assets and related goodwill. The portion contributed is used to calculate the cost of investment. Entity A recognises a gain or loss on the disposal of its businesses, calculated by reference to the difference between the fair value of the consideration received and the businesses’ carrying amount. The gain recognised in the consolidated financial statements is only to the extent of the other venturer’s interest (the realised portion). The impact on entity A’s financial statements is outlined below: Entity A’s consolidated financial statements Entity A – gain in consolidated financial statements C Fair value of consideration paid in proportion to the other investor’s share (C300 × 40%) (note 1) 120 Book value of business contributed to joint venture in proportion to the other investor’s share (C200 × 40%) (note 2) (80) Entity A gain on disposal 40 Note 1: IAS 28 requires that, on initial recognition, the investment should be recorded at cost, which is the amount of cash or cash equivalents paid (or the fair value of the other consideration given) to acquire an asset at the time of its acquisition or construction. Entity A contributes an interest in a business to the joint venture with a fair value of C300. This is the fair value of the amount contributed by entity B, including goodwill when apportioned for the relevant percentage holding (40%/60% × C300). Entity A’s contribution is equal to entity B’s share in the joint venture − in this case, 40%. Note 2: Entity A contributes a business with a book value of C200 (including goodwill). The share of entity A’s business sold to entity B equals the amount invested in the joint venture by entity B − in this case, 40%. This gain of C40 represents the realisation of 40% of the difference between the fair value and the carrying value of the business in entity A’s subsidiary immediately before the transaction. Entity A recognises this transaction in its consolidated financial statements as follows: C C Cr Carrying value of contributed 200 (being the disposal of 100% business of the carrying value of business in entity A) Cr Gain on disposal 40 (as calculated above) Dr Investment in joint venture 240 (balancing figure) The total equity interest in the joint venture is measured at C240. This includes the C120 share of the previous net assets retained (that is, original assets of C200 × 60%) plus the C120 share of the fair value of the business acquired. This is not equal to 60% of the total fair value of the assets owned by the joint venture; but it is equal to the fair value of the equity interest received of C300 (that is, 60% of C500) less the unrealised gain of C60. The investment in the joint venture of C240 includes the total goodwill of C108. The goodwill relates to the sum of: ·        60% of the retained entity’s A business (60% × C100); and ·        60% of the acquired entity’s B business (as calculated below). Entity A – goodwill calculation C Fair value of the consideration given: 40% of fair value of entity A’s business contributed to joint venture (C300 × 40%) 120 Fair value of net identifiable assets acquired from entity B (C120 × 60%) (72) Entity A’s share of goodwill in entity B’s subsidiary business acquired 48 Entity A’s separate financial statements  Entity A – gain in separate financial statements Entity A recognises this transaction in its separate financial statements as follows: C C Dr Investment in joint venture 300 Cr Investment in subsidiary (being the previous carrying value of the investment) 200 Cr Gain on disposal 100

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Venturer transfers a business to a joint venture in exchange for equity interest: accounting policy under IFRS 10 Entity A enters into a joint venture with entity B. Their relative interests in the joint arrangement are 60% and 40% respectively. The joint venturers agree to contribute businesses, which are held in subsidiaries and transferred as a share transfer, as follows: ·        Entity A held its investment in the subsidiary that contained the business at C200 (comprising C100 of net identifiable assets and C100 of goodwill), and the fair value of the business is C300. In its separate financial statements, entity A held its investment in the subsidiary that contained the business at a cost of C200. ·        Entity B held its investment in the subsidiary containing the business at C150 (comprising net identifiable assets with a book value of C100 and goodwill of C50), and the fair value of the business is C200. The fair value of the joint arrangement’s total net identifiable assets is C270, which comprises the fair value of the net identifiable assets of entity A of C150 and entity B of C120. The fair value of the joint venture’s business is C500. Entity A’s accounting policy is to follow the IFRS 10 rules, and so it recognises any gain or loss in full. Entity A’s consolidated financial statements  Entity A – gain in consolidated financial statements C C Dr Investment in joint venture (recorded at fair value) 300 Cr Carrying value of contributed business (C200 × 100%) (200) Cr Gain on disposal 100 The equity interest recognised in the consolidated financial statements can also be rationalised as follows: C 60% of the old business retained at fair value of C300 180 60% of fair value of business contributed by entity B to joint venture of C200 120 Total amount of equity interest in consolidated financial statements 300

Subsequent measurement

After initial recognition, the carrying amount of the investment in a joint venture is adjusted for the following:

• recognise the investor’s share of profit or loss in the joint venture;
• deduct distributions to the investor; and
• recognise the investor’s share of changes in other comprehensive income;
• the corresponding adjustment should be directly within the investor’s other comprehensive income.

The results of the joint venture should be adjusted such that the investor and the investee apply uniform accounting policies.

The share of profit of the joint venture is adjusted to account for the impact of the initial acquisition of the joint venture. For example, if, on acquisition of the joint venture, there was a fair value uplift in property, plant and equipment when assessing the fair value of the identifiable assets acquired, the profit should be adjusted for the additional depreciation that arises from such uplift.

The venturer’s investment in a joint venture in its consolidated financial statements is shown as a separate line item on the balance sheet. It is initially recognised at cost and is subsequently adjusted by the joint venture’s share of profit or loss and other comprehensive income.

Where a joint venture’s financial statements are used for the purpose of including results in the investor’s financial statements, they should preferably be coterminous with those of the investor. Where the joint venture prepares its annual financial statements to a different year end, it would need to prepare special purpose financial statements to the same date as the joint venturer’s year end.

Upstream and downstream transactions

Investors might sell or contribute assets to the joint venture. The joint venture might sell assets to the investor. Gains and losses resulting from such ‘downstream’ and ‘upstream’ transactions between the investor and the joint venture are recognised in the investor’s financial statements only to the extent of unrelated investors’ interests in the joint venture. The investors’ share in the joint venture’s gains or losses resulting from upstream and downstream transactions is eliminated.

The investor must recognise the full impairment charge in its books if the transaction provides evidence of an existing impairment. It is presumed that the asset was already impaired before the sale to the joint venture.

A joint venturer might contribute non-monetary assets, such as property, plant and equipment, to a joint venture in exchange for equity. Where the transaction lacks commercial substance, as explained in IAS 16, the entire gain or loss is not recognised. The gains or losses are eliminated against the investment in the joint venture.

If an entity receives monetary or non-monetary assets in addition to the equity interest, the investor recognises in full, in profit or loss, the portion of the gain or loss on the non-monetary contribution relating to the monetary or non-monetary assets received.

Changes in ownership interests and loss of joint control

Management should discontinue use of the equity method of accounting, when the entity ceases to exercise joint control, unless the retained interest is an investment in an associate for which equity accounting is also applied. Loss of joint control might happen in different ways:

1. An entity gains control of a previous joint venture. The investor applies IFRS 3 and IFRS 10 to determine the accounting for the transaction. The interest held in the investee is remeasured to fair value, and it forms part of the consideration transferred to obtain control.
2. An entity retains an investment which is neither a subsidiary nor an associate. The interest is accounted for as a financial asset under IFRS 9 (IAS 39). The fair value of the retained interest when joint control is lost becomes the fair value on initial recognition under those standards.

An entity becomes an investor in an associate when it loses joint control over a joint venture but retains significant influence. The entity continues to equity account for its interest in accordance with IAS 28. It does not remeasure its continuing ownership interest to fair value.

Where the ownership interest is reduced and the investment becomes an associate or continues to be joint venture (that is, retaining joint control with reduced interest), the entity might need to reclassify to profit or loss a proportion of the gains or losses recognised in other comprehensive income, where disposal of the related assets and liabilities would require any gains or losses to be reclassified in profit or loss.

Changes in levels of ownership whilst retaining joint control IFRS 11 and IAS 28 do not deal with an increase in ownership interest in a joint venture while retaining joint control. In our view, the cost of the additional interest is added to the existing carrying amount. Notional goodwill is calculated by comparing the cost of the additional interest to the relevant share of the joint venture’s net identifiable assets and liabilities. There is no step-up to fair value of the previously held interest, because there has been no remeasurement event.

Impairment

Investments in associates and joint ventures are assessed for impairment where indicators of impairment are present. Impairment indicators are as described in IAS 28 (previously IAS 39).

Measurement of long-term interests that, in substance, form part of the net investment In June 2016, the IASB tentatively decided to finalise the proposed amendments to IAS 28, ‘Investments in associates and joint ventures. The amendments clarify that IFRS 9, ‘Financial Instruments’, applies to long-term interests in associates or joint ventures. Long-term interests are interests that, in substance, form part of the net investment but are not accounted for using equity accounting. The Board tentatively decided also to clarify in IAS 28 that: ·        the IFRS 9 requirements are applied to long-term interests before applying the loss allocation and impairment requirements of IAS 28; and ·        the entity should not take account of any adjustments to the carrying amount of long-term interests that result from the application of IAS 28, when applying the IFRS 9 requirements. The Board tentatively decided to develop educational material to illustrate the interaction between IAS 28 and IFRS 9 in relation to long-term interests. The Board tentatively decided to set an effective date of 1 January 2019, with earlier application permitted. Retrospective application would be required in accordance with IAS 8. Transition requirements for entities that apply the amendments after they first apply IFRS 9 would be similar to those in IFRS 9 regarding classification and measurement.

The entire carrying amount of the investment is tested for impairment under IAS 36, to determine the amount of the impairment loss. The carrying amount comprises equity interests and any long-term interests that are part of the entity’s net investment. Goodwill included in the carrying value of the investment in joint venture is not tested for impairment annually nor tested separately, but it is considered as part of the entire investment.

Economic interest or separate financial statements of the venturer

An entity should use equity accounting to account for its investments in joint ventures in its consolidated financial statements. However, if it does not have any subsidiaries, it should also use equity accounting to account for its investments in joint ventures in its financial statements, even though these might not be called ‘consolidated financial statements’. These are referred to as ‘economic interest financial statements.

The joint venturer’s interest in the joint venture is measured in the venturer’s separate financial statements at cost or in accordance with IFRS 9 (IAS 39), or using equity accounting.

Venturers that are exempt from the requirement to consolidate or equity account their investments, as a result of the exemption in IAS 28 or IFRS 10, could present separate financial statements as their only financial statements − in which case, they are not required to equity account joint ventures.

C. Parties to a joint arrangement that do not share joint control

Party to a joint operation

The parties that do not share joint control should evaluate whether they have rights to individual assets and obligations for liabilities, because they would need to account for these in their financial statements. Their accounting would be similar to joint operators. Parties that do not share joint control might not have direct rights to assets and obligations for liabilities. For example, this might be the case where a party has contributed funding to a joint operation in return for a right to a share of the output from the joint operation, as opposed to direct rights to assets or obligations for liabilities. Parties that do not have rights to individual assets should account for their investment in accordance with the relevant IFRSs.

The investors in a joint operation, including those who do not share joint control, account for their rights and obligations. They recognise, in both their consolidated and separate financial statements, the assets and obligations that arise from the joint arrangement.

Party to a joint venture

A party to a joint venture that does not share joint control should account for its investment in the consolidated financial statements in accordance with IFRS 9 (IAS 39), or in accordance with IAS 28 if the party has significant influence.