Accounting for Join Ventures/ Joint Arregements.
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Changes to joint venture accounting
The financial statements of many mining companies could look very different in the future as a result of the changes to the accounting for joint arrangements (formerly
joint ventures). This could affect key performance measures and ratios for companies in the sector, which raises the question of how such changes should be
communicated to investors and other stakeholders.
Assessing the effect of the new requirements for your company may take significant time and judgement. The number and variety of joint arrangements in the mining
sector means that planning for transition in advance of the 1 January 2013 effective date is of particular importance.
Key questions that you should consider asking yourself
Question
Considerations
I proportionately consolidate jointly controlled entities – what will the changes mean for my financial statements?
The option to proportionately consolidate has been eliminated. Assuming that there is no change to the classification of arrangements, a change from proportionate
consolidation to equity accounting will affect virtually all financial statement line items, notably decreasing revenue, gross assets and gross liabilities. If the
joint venture has tax expense, then transition will also decrease profit before tax. See page 3.
I equity account my jointly controlled entities – does this mean there will be no significant change?
The change to the definitions of different types of arrangements may mean that some jointly controlled entities will be accounted for on a line-by-line basis under the
new standard.
In this case, individual balances in the financial statements will change. For example, the operating profit of the arrangement will form part of your total operating
profit. See page 3.
What determines the classification of joint arrangements under the new standard?
In summary, arrangements in which you have joint control and individual rights/obligations to the underlying individual assets and liabilities will be accounted for on
a line-by-line basis. If the rights are to net assets, then equity accounting will apply. However, the process for assessing these rights follows a series of tests,
and analysis of the detail of the legal and contractual arrangements, as well as the substance of those arrangements, will be required. This will require judgement and
could well be time-consuming if you have a number of arrangements. See page 5.
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2
How do the new rules for accounting for joint arrangements differ from current requirements?
IFRS 11 Joint Arrangements was issued to replace IAS 31 Interests in Joint Ventures. As well as changes to terminology, the new standard brings some potentially
significant accounting changes.
Put simply, IFRS 11 does two things.
• First, it changes the classification of IAS 31 jointly controlled entities if separation between the arrangement and the party is deemed ineffective. These
arrangements are treated similarly to jointly controlled assets/operations under IAS 31 and are now called joint operations.
• Second, the free choice of using the equity method or proportionate consolidation to account for the remainder of IAS 31 jointly controlled entities, now called
joint ventures, is eliminated; joint venturers must now always use the equity method.
The remainder of this publication discusses what these changes could mean for the financial statements and processes of mining companies. It also highlights the main
areas of judgement to be considered.
The most time-consuming part of planning for transition will be reviewing arrangements to determine the classification for accounting purposes. This will involve
judgement and the consideration of more factors than under current requirements.
IFRS 11 sub-categorises arrangements into:
• joint operations, whereby the parties with joint control have rights to the assets, and obligations for the liabilities, relating to the arrangement; and
• joint ventures, whereby the parties with joint control have rights to the net assets of the arrangement.
The differences between the joint arrangement classification and accounting models of the existing IAS 31 and the new IFRS 11 can be illustrated as follows.
Key
JCO/JCA: Jointly controlled operation/jointly controlled asset JO: Joint operation
JCE: Jointly controlled entity JV: Joint venture
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3
Impact 1: No more proportionate consolidation
Under IAS 31, there was an accounting policy choice available to account for interests in jointly controlled entities: either proportionate consolidation or the equity
method. IFRS 11 removes the option to apply proportionate consolidation and requires equity accounting for joint ventures.
The IASB’s view is that proportionate consolidation is not appropriate in the absence of rights/obligations directly to/for the separate assets/obligations of the
arrangement.
Some companies felt that there was little substantive difference between their jointly controlled entities and other joint arrangements and appreciated being able to
account for these in a similar way. IFRS 11 removes this option.
The elimination of proportionate consolidation is expected to significantly affect a number of companies in the mining sector. In KPMG’s 2009 publication Application
of IFRS: Mining, proportionate consolidation was found to be applied by just over half of the companies included in the survey who had jointly controlled entities.
The equity accounting requirement relates to joint ventures under the IFRS 11 definition. The term joint venture is a widely used operational term in the mining sector
that can refer to a variety of risk-sharing arrangements that will not necessarily meet the IFRS 11 definition.
Effects to be considered on transition from proportionate consolidation to equity accounting
Changes to the presentation of financial statements
There is a potentially significant effect on the presentation of key line items in the financial statements and on important performance measures. For example, revenue
and assets and liabilities will decrease, and operating result will change if the result of joint ventures will be shown outside of operating profit.
There may also be other consequential effects resulting from the cessation of proportionate consolidation. For example, a venturer’s interest expense may no longer be
capitalised into a joint venture’s assets.
Communication
The effect of changes to the financial statements on debt and remuneration agreements and performance measures should be assessed. If this is expected to be
significant, then you will need to consider the timing and form of communications with lenders, shareholders, analysts, employees and other stakeholders.
In some cases, you may wish to consider re-negotiating existing contracts to take into account the effect of transition.
Systems
Depending on whether equity accounting was already applied in preparing the financial statements, consolidation systems may need to be updated to reflect the new
accounting approach.
Impact 2: Changes to definitions will affect accounting and require analysis
Under IFRS 11, joint arrangements are essentially defined in the same way as under IAS 31: an arrangement over which there is joint control. What is new is the way in
which IFRS 11 sub-categorises joint arrangements.
Mining companies commonly use joint arrangements to share risks and costs, for example sharing interests in a mine, or jointly running rail facilities. The form of
arrangements varies considerably and therefore determining the appropriate accounting requires careful consideration and judgement.
Joint control
The first step will be to consider recent changes to the definition of ‘control’. Joint control exists when there is a contractual agreement that decisions about the
relevant activities require the unanimous consent of the parties. The need for a contract to confer joint control is not new. However, the definition of control has
changed as a result of IFRS 10 Consolidated Financial Statements, which is applicable from the same date as IFRS 11.
4 © 2012 KPMG IFRG Limited, a UK company, limited by guarantee. All rights reserved.
Under IFRS 10, an investor has control when it is exposed, or has rights, to variable returns from its involvement with that investee and has the ability to affect
those returns through its power over the investee. The new control model requires identification of how decisions affecting ‘relevant activities’ are made. These
relevant activities typically exclude decisions that apply only in exceptional circumstances, such as on liquidation.
Details of arrangements need to be assessed to determine if these new definitions change the list of joint arrangements for accounting purposes.
There are often a number of different agreements that may influence this assessment, including terms of reference, joint operating agreements and even agreements with
operators. An operator of a mine, for example, may determine day-to-day decisions about the arrangement, but that will not necessarily mean that the operator has
control. In fact, in many cases the operator is clearly subject to key strategic decisions made by the partners. As a result, being the operator alone will not
determine control in many cases; however, the specific nature of the agreements in place should be assessed.
Classification of joint arrangements
There are two classifications for joint arrangements under IFRS 11: joint operations and joint ventures. The definition of each classification differs from that of IAS
31. The structure of the joint arrangement is no longer the sole factor determining the accounting.
The new classifications may result in an accounting result similar to proportionate consolidation for some arrangements previously accounted for as jointly controlled
entities. There are specific tests to be applied in making this determination. These tests are designed to take a more substance-based approach to classification and
they may introduce additional judgement into the process.
The process to be followed to determine the classification of arrangements is discussed on page 5.
Effects to be considered on transition to the new classifications of joint arrangements
Changes to the presentation of financial statements
The effect on the financial statements will depend on the specific arrangements in place.
Arrangements that are not structured through a separate vehicle (such as a company) will be joint operations. Therefore, arrangements currently classified as jointly
controlled assets or jointly controlled operations will be joint operations under IFRS 11 and the accounting for these will not change significantly.
Arrangements structured through a separate vehicle may be joint operations or joint ventures depending on the terms and circumstances of the arrangement.
The accounting for joint operations is similar to that currently applied for jointly controlled assets and jointly controlled operations: recognition of the assets and
liabilities controlled and recognition of income generated and expenses incurred in relation to the company’s share in the joint operation.
Changing classification from jointly controlled entity to joint operation will therefore affect the financial statements when those arrangements were previously equity
accounted.
Communication
The effect of changes to financial statements on debt and remuneration arrangements and performance measures will need to be assessed. If this is expected to be
significant, then you will need to consider the timing and form of communications with lenders, shareholders, analysts, employees and other stakeholders.
Systems
Transition to IFRS 11 will require an assessment of all joint arrangements, and may require experienced staff.
Depending on the changes in classification that arise under the new standard, accounting systems may need to be updated for changes in approach.
© 2012 KPMG IFRG Limited, a UK company, limited by guarantee. All rights reserved. 5
How to determine the classification of joint arrangements
The considerations for determining the form of a joint arrangement have changed. Changes to classification may significantly affect the accounting treatment.
There are two classifications for joint arrangements under IFRS 11, which can be defined as follows.
• In a joint operation, each jointly controlling party has rights to the separate assets and obligations for the liabilities relating to the arrangement.
• In a joint venture, each jointly controlling party has rights to the net assets of an arrangement.
The classification process is summarised in the following flowchart.
In practice, the number and variety of joint arrangements in the mining sector means that there may be more entities that qualify as joint operations than in other
industries, although this will depend on the circumstances of each arrangement.
Structure
The structure of the arrangement is the first factor to be considered in assessing the type of arrangement, but it is not the sole determining factor. If an
arrangement is structured through a separate vehicle (such as a company), then the arrangement could be a joint operation or a joint venture, depending on the rights
and obligations.
If an arrangement is not structured through a separate vehicle, then the arrangement will be a joint operation. As a result, arrangements currently classified as
jointly controlled assets or jointly controlled operations will be joint operations under the new standard.
6 © 2012 KPMG IFRG Limited, a UK company, limited by guarantee. All rights reserved.
Legal form and contractual arrangements
The next two steps in determining the classification of
arrangements structured through a separate vehicle are
the legal form of the arrangement and the contractual
arrangements surrounding it. If these give the controlling
parties rights to assets and obligations for liabilities, then the
arrangement is a joint operation.
In some jurisdictions, partnership arrangements offer the
parties no separation between them and the vehicle itself. As
a result, such cases would be classified as joint operations
under IFRS 11. Otherwise, we expect that most separate
vehicles will provide legal separation between the parties and
the vehicle.
Contractual arrangements surrounding a joint arrangement
can vary considerably. For example, parties commonly
provide guarantees to third parties for financing provided to
the arrangement. However, a guarantee alone is not in itself
an indicator that the arrangement is a joint operation, as it
does not provide the parties with direct rights to assets and
obligations for liabilities.
Example
A separate vehicle, entity X, undertakes exploration, development and production activity. The main feature of X’s legal form
is that X (and not the parties) has the rights to the assets and obligations for the liabilities relating to the arrangement.
The contractual agreement between X and the parties specifies that the rights and obligations arising from the joint
arrangement’s activities are shared among the parties in proportion to their holding in X, and in particular that the parties
share the rights and obligations arising from the exploration and development permits granted to X, the production obtained
and all related costs.
Costs incurred in relation to all work programmes are covered by cash calls on the parties, and in the event that a party fails
to meet its monetary obligations, the other party is required to contribute to X the amount in default; that amount will be
considered debt owed by the defaulting party to the other party.
In this case, the legal form provides the separate vehicle alone with rights to the assets and obligations for the liabilities;
therefore, there is an initial indication that the arrangement is a joint venture. However, as the contractual arrangement
explicitly provides the parties with rights to assets and obligations for liabilities, that initial indication is reversed and the joint
arrangement is determined to be a joint operation.
Other facts and circumstances
The final consideration is whether there are any other facts
or circumstances that give the controlling parties rights to
substantially all of the economic benefits of the assets and
make the parties in substance responsible for liabilities.
When the activities of the arrangement are designed to
provide output to the parties and the arrangement is limited
in its ability to sell to third parties, this indicates that the
parties have rights to substantially all the economic benefits
of the arrangement’s assets. Such an arrangement also has
the effect that the liabilities incurred by the arrangement
are, in substance, satisfied only by the cash flows received
from the parties through their purchase of the output. When
the parties are substantially the only source of cash flows
contributing to the arrangement’s operations, this indicates
that the parties have an obligation for the liabilities relating to
the arrangement.
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How are interests in joint arrangements accounted for?
The table below sets out the accounting for different arrangements.
Consolidated financial statements
Separate financial statements
Joint venturers
Equity method in accordance with IAS 28 (2011) Investments in Associates and Joint Ventures.
Choice between cost or in accordance with IFRS 9 Financial Instruments/IAS 39 Financial Instruments: Recognition and Measurement.
Joint operators
Recognises its own assets, liabilities and transactions, including its share of those incurred jointly.
Other parties to a joint venture
If significant influence exists, then equity method in accordance with IAS 28 (2011); otherwise, in accordance with IFRS 9/IAS 39.
If significant influence exists, then choice between cost or in accordance with IFRS 9/IAS 39; otherwise, in accordance with IFRS 9/IAS 39.
Other parties to a joint operation
Recognises its own assets, liabilities and transactions, including its share of those incurred jointly, if it has rights to the assets and obligations for the
liabilities.
Otherwise, it accounts for its interest in accordance with the IFRS applicable to that interest, e.g. IAS 28 (2011) or IFRS 9/IAS 39, as the case may be.
Accounting for joint ventures
IFRS 11 requires equity accounting for joint ventures in consolidated financial statements. The investment in the joint venture will be recognised initially at cost
and adjusted for changes in the investor’s share of the profit or loss of the joint venture throughout the arrangement.
Accounting for joint operations
In a joint operation each party controls its own assets and has obligations for expenses it incurs. Therefore, a joint operator recognises its assets, liabilities,
revenues and expenses, including its share of those held or incurred jointly. These are accounted for in accordance with the applicable IFRS.
This approach is similar to that in IAS 31 for jointly controlled assets/jointly controlled operations. Therefore, the accounting for joint operations not structured
through a separate vehicle is not expected to be significantly different from that previously applied.
Accounting for interests in joint arrangements when you don’t have joint control
IFRS 11 also sets out the accounting for joint arrangements by parties that do not have joint control. An investor in a joint operation accounts for its investment in
the same way as a joint operator. However, this applies only if the investor has rights to assets and obligations for liabilities. Otherwise, it accounts in accordance
with the applicable IFRS, e.g. IAS 28 or IFRS 9/IAS 39.
This is a change from the previous requirement to account for investments in jointly controlled operations/assets in accordance with IAS 39/IFRS 9, or IAS 28 when
significant influence existed.
IFRS 11 carries forward the existing requirements of IAS 31 for parties to joint ventures that do not participate in joint control; therefore, if IAS 31 jointly
controlled entities are classified as IFRS 11 joint ventures, then we do not expect a significant effect on the accounting by investors.
© 2012 KPMG IFRG Limited, a UK company, limited by guarantee. All rights reserved.
Publication name: Impact on mining companies: changes to joint venture accounting
Publication number: 120314
Publication date: February 2012
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