IAS 31 Interests in Joint Ventures and IFRS 11 Joint Arrangements

1 INTRODUCTION

In May 2011, the IASB issued IFRS 11 “Joint Arrangements.” The new standard has to be applied in the financial statements as at Dec 31, 2013 (if the entity's reporting periods start on Jan 01 and end on Dec 31). Earlier application is permitted by the IASB (IFRS 11.C1). However, in the European Union, new IFRSs have to be endorsed by the European Union before they can be applied. There has been no endorsement with regard to IFRS 11 as yet.

If an entity decides not to apply IFRS 11 early, the rules of IAS 31 “Interests in Joint Ventures” have to be applied. Consequently, the remainder of this chapter of the book discusses both standards:

• Section 2 gives an overview over the rules of IAS 31.
• Section 3 introduces the rules of IFRS 11.

2 IAS 31 “INTERESTS IN JOINT VENTURES”

2.1 The Term “Joint Venture” and Forms of Joint Ventures

The following characteristics are common to all joint ventures (IAS 31.3 and 31.7):

• Two or more venturers are bound by a contractual arrangement.
• The contractual arrangement establishes joint control.

Joint control is the contractually agreed sharing of control over an economic activity, and exists only when the strategic financial and operating decisions relating to the activity require the unanimous consent of the parties sharing control (the venturers). A venturer is a party to a joint venture which has joint control over that joint venture (IAS 31.3).

IAS 31 sets out the accounting treatment of interests in joint ventures and differentiates between the following types of joint ventures:

• Jointly controlled operations are carried on by each venturer using its own assets in pursuit of the joint operation. The agreement usually provides a means by which the revenue from the sale of the joint product and any expenses incurred in common are shared among the venturers. For example, three construction companies may agree to act as a consortium to construct a hotel for a customer. One contract is signed between the members of the consortium and the customer. All three companies are party to the contract as the consortium is not a legal entity.1
• Jointly controlled assets arise from an arrangement that is a joint venture carried on with assets that are controlled jointly, whether or not owned jointly, but not through a separate entity. In addition, one's own assets can be used. An example is two oil producers sharing the use of a pipeline to transport oil. Both parties bear an agreed proportion of the operating expenses.2
• Jointly controlled entities are joint venture activities carried on through separate entities (e.g. corporations or partnerships) (IAS 31.24). Jointly controlled entities are the most common form of joint ventures. An example is the founding of a sales company in Japan by a German producer together with a Japanese chain.

2.2 Accounting Treatment in the Financial Statements of the Venturer

2.2.1 Jointly Controlled Operations in Consolidated and Separate Financial Statements

With respect to its interests in jointly controlled operations, a venturer recognizes (IAS 31.15):

• the assets that it controls and the liabilities that it incurs, as well as
• the expenses that it incurs and its share of the income that it earns from the sale of goods or services by the joint venture.

Jointly controlled assets do not exist in jointly controlled operations.

2.2.2 Jointly Controlled Assets in Consolidated and Separate Financial Statements

In the case of jointly controlled assets, the venturer recognizes its share of the jointly controlled assets and its share of any liabilities incurred jointly with the other venturers in relation to the joint venture, in addition to its own assets and liabilities. Moreover, the venturer recognizes the expenses it has incurred in respect of its interest in the joint venture, its share of any expenses incurred by the joint venture, and any income from the sale or use of its share of the output of the joint venture (IAS 31.21).

2.2.3 Jointly Controlled Entities

2.2.3.1 Separate financial statements

In the venturer's separate financial statements, interests in jointly controlled entities are accounted for either (IAS 31.46 and IAS 27.38):

If investments in jointly controlled entities are accounted for in accordance with IFRS 9 in the consolidated financial statements, they have to be accounted for in the same way in the venturer's separate financial statements (IAS 27.40).

2.2.3.2 Consolidated financial statements

In the venturer's consolidated financial statements, interests in jointly controlled entities are accounted for in one of the following ways (IAS 31.30 and 31.38):

• Proportionate consolidation: According to this method, the venturer recognizes its share of the assets that it controls jointly and of the liabilities for which it is jointly responsible. Moreover, the venturer recognizes its share of the income and expenses of the jointly controlled entity.
• Equity method: This method is not described in IAS 31 but rather in IAS 28. Therefore, we refer to the chapter on IAS 28.4

When applying proportionate consolidation, it is possible to choose between one of the two reporting formats described later (IAS 31.34):

• Combined presentation: The venturer combines its share of each of the assets, liabilities, income, and expenses of the jointly controlled entity with the similar items, line by line, in its financial statements. For example, the venturer combines its share of the jointly controlled entity's inventory with its inventory.
• Separate presentation: The venturer includes separate line items for its share of the assets, liabilities, income, and expenses of the jointly controlled entity in its financial statements.

When applying proportionate consolidation, the procedures for the consolidation of subsidiaries are applied correspondingly (IAS 31.33):5

• If the balance sheet date of the jointly controlled entity differs from the balance sheet date of the consolidated financial statements, it might be necessary to prepare additional financial statements.
• Adjustment to uniform accounting policies.
• When capital consolidation is carried out, fair value adjustments, and goodwill are recognized. Subsequently, goodwill is not amortized. Instead, it has to be tested for impairment. Fair value adjustments of depreciable assets have to be depreciated.
• Negative goodwill is immediately recognized in profit or loss.
• Elimination of intragroup receivables and liabilities.
• Elimination of intragroup income and expenses.
• Elimination of intragroup profits and losses that are recognized in the carrying amounts of assets.

The consolidation entries are only effected to the extent of the venturer's interest in the jointly controlled entity.

2.3 Example with solution

Examples relating to the equity method are included in the chapter on IAS 28.

Example 1

Proportionate consolidation of a jointly controlled entity

Entity A and entity B each own 50% of the jointly controlled entity J. On Dec 31, 01, B sells its shares for CU 45 to entity E. The following table includes simplified illustrations of the statements of financial position II of E and J as at Dec 31, 01:6

	E	J (100%)
Buildings	–90	–40
Merchandise	–50	–20
Cash	–15
Investment of E in J (shares)	–45
Total assets	–200	–60
Issued capital	−130	−30
Retained earnings	−70	−30
Total equity and liabilities	−200	−60

The fair value of J's buildings as at Dec 31, 01 is CU 60.

In its separate financial statements as at Dec 31, 01, E accounts for its investment in J (shares) at cost (IAS 31.46 and IAS 27.38a).

Posting status (in E's separate financial statements):

Required

Prepare any necessary entries in E's consolidated financial statements as at Dec 31, 01 and present E's consolidated statement of financial position as at Dec 31, 01. E applies proportionate consolidation with respect to its interests in jointly controlled entities.

Hints for solution

In particular Section 2.2.3.2.

Solution7

The aggregated statement of financial position is prepared first, which also incorporates 50% of J's statement of financial position. Afterwards, proportionate consolidation is carried out (including the recognition of the pro rata fair value adjustment for the building). This results in E's consolidated statement of financial position:8

The goodwill presented in the table above is the positive difference between the acquisition cost of CU 45 and the fair value of the net assets on acquisition date:

Acquisition cost		45
Proportionate issued capital	15
Proportionate retained earnings	15
Proportionate fair value adjustment	10
Proportionate net assets (measured at fair value)		40
Goodwill		5

In order to improve the illustration, the entry for capital consolidation is given again:

---

3 IFRS 11 “JOINT ARRANGEMENTS” (ISSUED IN MAY 2011)

3.1 Introduction

In May 2011, the IASB issued IFRS 11, which supersedes IAS 31 “Interests in Joint Ventures” as well as the Interpretation SIC 13 “Jointly Controlled Entities – Non-Monetary Contributions by Venturers” (IFRS 11.C15). IFRS 11 applies to all entities that are a party to joint arrangement (IFRS 11.3).

The main changes to financial reporting caused by IFRS 11 are the following:

• The terminology and the definitions of different types of arrangements that are jointly controlled have changed.
• IFRS 11 prohibits proportionate consolidation for including jointly controlled entities (which are referred to as joint ventures by IFRS 11) in the venturer's consolidated financial statements.9

IFRS 11 has to be applied in the financial statements as at Dec 31, 2013 (if the entity's reporting periods are identical with the calendar years). Earlier application is permitted (IFRS 11.C1). In the European Union, there has been no endorsement of IFRS 11 as yet.10

A joint arrangement represents an arrangement of which two or more parties have joint control (IFRS 11.4 and 11.Appendix A). A joint arrangement has both of the following characteristics (IFRS 11.5):

• The parties are bound by a contractual arrangement. The contractual arrangement specifies the terms upon which the parties participate in the activity that is the subject of the arrangement (IFRS 11.B4).
• The contractual arrangement gives two or more of those parties joint control of the arrangement.

Joint arrangements are established for a variety of purposes. For instance, they may be established in order to enable the parties to share costs and risks, or as a way to provide the parties with access to new markets or new technology (IFRS 11.B12).

3.2 Assessing Joint Control

Joint control is the contractually agreed sharing of control of an arrangement. It exists only when decisions about the relevant activities (i.e. activities that significantly affect the returns of the arrangement) require the unanimous consent of the parties sharing control (IFRS 11.7, 11.9, and 11.Appendix A).

Hence, assessing whether a party has joint control of an arrangement as a result of a contract involves the following steps (IFRS 11.4, 11.8–11.11, 11.Appendix A, 11.B5-11.B6, and 11.B9–11.B10):

• It first has to be determined whether all the parties or a group of the parties control the arrangement collectively. The Standard IFRS 10 defines control and has to be used in order to determine whether all the parties or a group of the parties are exposed or have rights to variable returns from their involvement with the arrangement and have the ability to affect those returns through their power over the arrangement.11 When all the parties or a group of the parties considered collectively are able to direct the relevant activities, these parties control the arrangement collectively.
• After concluding that the arrangement is controlled collectively (see above), it has to be determined whether the decisions about the relevant activities require the unanimous consent of the parties that collectively control the arrangement. If this is the case, the arrangement is jointly controlled and represents a joint arrangement. The requirement for unanimous consent means that any party with joint control of the arrangement is able to prevent any of the other parties or a group of the parties from making unilateral decisions about the relevant activities without its consent.

When the minimum required proportion of the voting rights necessary to make decisions about the relevant activities can be achieved by more than one combination of the parties agreeing together, the arrangement does not represent a joint arrangement (unless the contractual arrangement specifies which parties or combination of parties are required to agree unanimously to decisions about the relevant activities of the arrangement) (IFRS 11. B8).

3.3 Types of Joint Arrangement

3.3.1 Introduction

A joint arrangement is either a joint operation or a joint venture (IFRS 11.6). In assessing in which type of joint arrangement a party is involved, the party has to consider its rights and obligations arising from the arrangement in the normal course of business (IFRS 11.15–11.17, 11.Appendix A, and 11.B14):

• In the case of a joint operation, the parties that have joint control of the arrangement have rights to the assets, and obligations for the liabilities, relating to the arrangement. Those parties are called joint operators.
• In the case of a joint venture, the parties that have joint control of the arrangement have rights to the net assets of the arrangement. Those parties are called joint venturers.

Joint arrangements can be established using different structures and legal forms. In some cases, the activity that is the subject of the arrangement is undertaken in a separate vehicle. In other cases, no separate vehicle is established (IFRS 11.B12–11.B13). A separate vehicle is a separately identifiable financial structure, including separate legal entities or entities recognized by statute, regardless of whether those entities have a legal personality (IFRS 11.Appendix A).

As described above, a party to an arrangement has to consider its rights and obligations arising from the arrangement in the normal course of business. When making that assessment the party has to consider the following (IFRS 11.17, 11.B14, 11.B15, and 11.B21):

• The structure of the joint arrangement.
• When the joint arrangement is structured through a separate vehicle:

• The legal form of the separate vehicle.
• The terms agreed by the parties in the contractual arrangement.
• When relevant, other facts and circumstances.

3.3.2 Structure of the Joint Arrangement

3.3.2.1 Joint arrangements not structured through a separate vehicle

A joint arrangement not structured through a separate vehicle is a joint operation. In such cases, the contractual arrangement establishes the parties' rights to the assets and obligations for the liabilities relating to the arrangement as well as the parties' rights to the corresponding revenues and their obligations for the corresponding expenses (IFRS 11.B16). In these cases, the parties agree to undertake activities together (for instance to manufacture a product together with each party responsible for a specific task and each party using its own assets and incurring its own liabilities) or to share and operate an asset together (IFRS 11.B17–11. B18).

3.3.2.2 Joint arrangements structured through a separate vehicle

A joint arrangement in which the assets and liabilities relating to the arrangement are held in a separate vehicle can represent either a joint venture or a joint operation (IFRS 11. B19).

The following chart gives a rough overview of the rules specified in IFRS 11.B22–11.B33 for assessing whether a joint arrangement structured through a separate vehicle represents a joint operation or a joint venture:12

3.4 Consolidated Financial Statements of Parties to a Joint Arrangement

IFRS 11 distinguishes between (IFRS 11.11 and 11.Appendix A):

• parties that have joint control of a joint arrangement (joint operators or joint venturers), and
• parties that participate in but do not have joint control of a joint arrangement.

3.4.1 Joint Operations

3.4.1.1 Joint operators

A joint operator recognizes the following in relation to its interest in a joint operation (IFRS 11.20):

• Its assets, including its share of any assets held jointly.
• Its liabilities, including its share of any liabilities incurred jointly.
• Its revenue from the sale of its share of the output arising from the joint operation.
• Its share of the revenue from the sale of the output by the joint operation.
• Its expenses, including its share of any expenses incurred jointly.

The assets, liabilities, revenues, and expenses relating to a joint operator's interest in a joint operation are accounted for in accordance with the IFRSs applicable to them (IFRS 11.21).

When the joint operator sells or contributes assets to the joint operation, it is conducting the transaction with the other parties to the joint operation. Hence, the joint operator recognizes gains and losses resulting from such a transaction only to the extent of the other parties' interests in the joint operation. When the joint operator purchases assets from the joint operation, it must not recognize its share of the gains and losses until it resells those assets to a third party (IFRS 11.22, 11.B34, and 11.B36).

3.4.1.2 Participants in a joint operation that do not have joint control

If a party participates in but does not have joint control of a joint operation, two situations have to be distinguished (IFRS 11.23):

• If such a party has rights to the assets and obligations for the liabilities relating to the joint operation, it accounts for its interest in the joint operation in the same way as a joint operator.
• If such a party does not have rights to the assets and obligations for the liabilities relating to the joint operation, it accounts for its interest in the joint operation according to the IFRSs applicable to that interest.

3.4.2 Joint Ventures

3.4.2.1 Joint venturers

A joint venturer has to recognize its interest in a joint venture as an investment and account for that investment using the equity method according to IAS 2813 (unless the entity is exempted from applying the equity method as specified in IAS 28) (IFRS 11.24).

3.4.2.2 Participants in a joint venture that do not have joint control

A party that participates in but does not have joint control of a joint venture has to account for its interest in the arrangement according to IFRS 9, unless it has significant influence over the joint venture in which case it has to account for it according to IAS 28 (IFRS 11.25).

3.5 Separate Financial Statements of Parties to a Joint Arrangement

IFRS 11 distinguishes between (IFRS 11.11 and 11.Appendix A):

• parties that have joint control of a joint arrangement (joint operators or joint venturers), and
• parties that participate in but do not have joint control of a joint arrangement.

3.5.1 Joint Operations

3.5.1.1 Joint operators

In its separate financial statements, a joint operator has to account for its interest in a joint operation in the same way as in its consolidated financial statements (IFRS 11.26a).

3.5.1.2 Participants in a joint operation that do not have joint control

In its separate financial statements, a party that participates in but does not have joint control of a joint operation has to account for its interest in the joint operation in the same way as in its consolidated financial statements (IFRS 11.27a).

3.5.2 Joint Ventures

3.5.2.1 Joint Venturers

In its separate financial statements, a joint venturer has to account for its interest in a joint venture according to IAS 27.10 (as amended in 2011) (IFRS 11.26b). Consequently, we refer to the chapter on IAS 27/IFRS 10 (Sections 2.5 and 4) in this regard.

3.5.2.2 Participants in a joint venture that do not have joint control

In its separate financial statements, a party that participates in but does not have joint control of a joint venture has to account for its interest according to IFRS 9 unless it has significant influence over the joint venture, in which case IAS 27.10 (as amended in 2011)14 has to be applied (IFRS 11.27b).

3.6 Example with solution

With regard to examples illustrating the application of the equity method, we refer to the chapter on IAS 28.

1 See KPMG, Insights into IFRS, 7th edition, 3.5.150.20.

2 See KPMG, Insights into IFRS, 7th edition, 3.5.150.10.

3 If IFRS 9 were not applied early, the investments would normally be measured at fair value. However, the equity instruments would be measured at cost if it were not possible to determine fair value reliably (IAS 39.AG80–39.AG81).

4 See the chapter on IAS 28, Section 2.2.

5 See the chapter on IAS 27/IFRS 10, Section 2.3 and the chapter on IFRS 3, Section 6.

6 In this table, debit entries and assets are shown with a plus sign, whereas credit entries, liabilities, and items of equity are shown with a minus sign. For simplification purposes, the exact presentation requirements of IAS 1 are ignored in this example.

7 For more information on the aggregated statement of financial position and capital consolidation, we refer to the chapter on IAS 27/IFRS 10, Section 2.3 and the chapter on IFRS 3, Sections 6 and 9.

8 In this table, debit entries and assets are shown with a plus sign, whereas credit entries, liabilities, and items of equity are shown with a minus sign.

9 See Section 2.2.3.2.

10 See Section 1.

11 See the chapter on IAS 27/IFRS 10, Section 3.2.

12 This chart is based on IFRS 11.B33.

13 See the chapter on IAS 28 with regard to the equity method.

14 See the chapter on IAS 27/IFRS 10, Sections 2.5 and 4.