Joint ventures
A joint venture is distinguished by the presence
of joint control; the contractually agreed sharing
of control over an economic activity [IAS31R.2]
. Joint control requires
all substantive decisions to be unanimously agreed
by all parties sharing joint control. The requirement
for a large voting majority, for example 80%, will
not necessarily be sufficient to establish joint
control.
There are three forms of joint venture; jointly
controlled operations, jointly controlled assets
and jointly controlled entities. All three are used
in the energy industry but the most common is jointly
controlled assets, most particularly in oil and
gas exploration, development and production.
A joint venture may have two or more parties although
a joint control assertion is progressively difficult
to sustain beyond three or four venturers . Control or joint control must also be carefully
evaluated where the government is a party to the
joint venture. The government party may have a stronger
role than the joint venture contract suggests.
Joint ventures in which one of the partners sharing
control has a very small ownership interest should
also be considered carefully and the reasons behind
the other partners being prepared to share control
with a very small stakeholder should be understood.
One venturer acting as operator for practical day-to-day
purposes does not necessarily prevent joint control
existing [IAS31R.12].
The accounting by a venturer for the formation
of a jointly controlled entity is prescribed by
IFRS although management has a choice in how to
present its holdings in jointly controlled entities
on an ongoing basis. The accounting for joint operations
and joint assets are prescribed by IFRS.
Jointly controlled
operations
Each venturer uses its own property,
plant and equipment and carries its own inventory.
It also incurs its own expenses and liabilities
and raises its own finance. Operations that involve
a sequential process to be performed in producing
the finished goods lend themselves well to the joint
operations format, with each venturer performing
one part of the sequential process. For example,
joint operations are often found where one party
controls mineral rights and has production facilities
and another party has transport facilities and /
or processing capacity . The parties
to the joint operation will share the revenue and
expenses of the jointly produced end product. Each
will retain title and control of its own assets.
The venturer should recognise 100% of the assets
it controls and the liabilities it incurs as well
as its own expenses and its share of income from
the sale of goods or services from the JV.
Jointly controlled
assets
The oil and gas industry is one of the
few areas where jointly controlled assets are commonly
found. A jointly controlled asset is usually constructed
by the joint owners, provides an essential shared
service and is not a separate legal entity. The
venturers will hold joint legal title over the asset.
An example would be a pipeline, refinery or offshore
loading platform that is jointly constructed and
owned by the oil companies with production facilities
in a large field or group of fields. The venturers
may also contribute existing assets or sell a share
of an existing asset to a co-venturer but these
are more likely to result in a jointly controlled
entity rather than a jointly controlled asset.
Each party to a jointly controlled asset should
recognise:
|
|
its share of the jointly controlled asset,
classified according to the nature of the asset; |
|
|
|
any liabilities the venturer has incurred; |
|
|
|
its proportionate share of any liabilities
that arise from the jointly controlled assets ; |
|
 |
its share of expenses from the operation of
the assets; and |
|
|
|
any income arising from the operation
of the assets (for example, ancillary fees from
use by third parties). |
Jointly controlled assets tend to reflect the sharing
of costs and risks rather than the sharing of profits.
The contribution of assets to a jointly controlled
asset arrangement will result in a partial disposal
of that asset by the contributing venturer. The
interest in that asset by the other venturers will
be at their share of the fair value of the asset
at the date of contribution. The accounting for
an interest in jointly controlled assets is similar
to the proportional consolidation model applied
for jointly controlled entities as described in
126.2.3 below.
Jointly controlled entities - Formation
A jointly controlled entity is a JV that
involves the establishment of a separate legal entity
- a corporation, partnership or other entity - that
the venturer has an ownership interest in . The JV entity operates in the same way as
other entities except that a contractual arrangement
between the venturers establishes joint control
over the operations of the entity .
Each venturer is entitled to a share of the output
or financial result of the joint venture.
The venturers often contribute fixed assets (or
the commitment to construct such), mineral rights
or cash and other assets. The formation of a jointly
controlled entity requires the venturer to account
for the assets it has contributed as a partial disposal.
For example, a jointly controlled entity is established
in which each venturer has a 50% interest. One party
contributes mineral rights and the other party contributes
production facilities. Each party has disposed of
50% of its interest in its own assets and acquired
a 50% interest in the other party's assets. Both
will recognise a gain or loss based on their share
of the fair value of the asset received less the
share of the book value of the asset disposed of
[SIC-13.5] .
There may be limited circumstances where gain recognition
is not appropriate:
|
|
when the risks and rewards relating to the
assets have not been transferred (seldom occurs
where control of the asset is with the JV); |
|
|
|
the gain or loss cannot be measured reliably;
or |
|
|
|
the contribution lacks commercial substance. |
|
The contribution of an existing business by one
venturer will often result in the recognition of
goodwill by the other venturers . This is because
the other venturers are acquiring a part-interest
in that business. The definition of a business should
be considered when identifying whether the contribution
represents a business [IFRS3.AppendixA]. Typically
interests in a mineral deposit that is in the development
or production stages will be a business whereas
an interest in an exploration phase resource will
not and should be accounted for as an interest in
assets.
The existing goodwill present in a business contributed
to a joint venture by one venturer is calculated
by the other venturers in the same way as goodwill
present in a business combination.
The purchase of an additional interest in a jointly
controlled entity will result in the recognition
of an additional interest in the assets and liabilities
of the jointly controlled entity. The additional
interest is recognised at the fair value at the
date of acquiring the additional interest but only
to the extent of the newly acquired interest in
the venture .
Jointly controlled operations and jointly controlled
assets typically represent the sharing of costs
and physical operations. Jointly controlled entities
may include the sharing of physical operations but
always include the sharing of financial results
rather than just the sharing of costs.
Jointly controlled
entities - presentation
A venturer has a choice of presentation
for its investments in jointly controlled entities.
The venturer can use proportionate consolidation
and show its interest in the assets, liabilities,
revenues and expenses of the entity or it can apply
equity accounting
. Both methods will generally
produce the same net financial results and differ
only in presentation .
An entity must choose a single method of accounting
for its interests in jointly controlled entities
and apply it consistently . The
joint venture must apply IFRS using the same accounting
policies as the venturer. The venturer must have
sufficient information to convert financial results
reported under national GAAP to IFRS for consolidation
when using either proportionate method or equity
method. There is no impracticability exception . It is increasingly common to see each venture
party's right to financial information on an appropriate
basis of accounting form part of the contractual
arrangement to establish the joint venture.
Investments with less than joint control (including undivided interests)
Energy and utilities entities may take an ownership
interest in a joint venture or other legal entity
but not be one of the venturers. This can arise with
shared assets such as a pipeline where the group of
users is too wide for joint control to be practical.
It also may result where the investor wishes to retain
influence and access to information but not joint
control. Often the legal entity will own a single
asset or closely related group of assets such as a
cracking plant or storage facility.
Joint venture accounting, as set out in IAS 31,
cannot be applied if there is not joint control.
Investments in which an investor does not have control
or joint control are accounted for according to
the nature of the investment and level of voting
power held. This could be one of the following,
each of which is considered further below:
|
Investment in associate where investor has
significant influence over an entity. Equity
accounting is applied; |
|
|
Investment in available for sales financial
asset where investor has less than significant
influence in an entity. Fair value accounting
is applied; |
|
|
|
Undivided interest where investor has direct
ownership interest in an asset. Recognise investor's
share of asset at cost less accumulated depreciation
and accumulated impairment. |
The interest is treated as an investment and is
either accounted for as an associate under IAS 28
where the investor has significant influence or an available for sale
asset under IAS 39 where an entity is involved.
The investment will often represent an undivided
interest in fixed assets owned by an unlisted company.
However, it is not appropriate to carry the investment
at cost less impairment when a reliable fair value
can be determined . Management
must obtain the information to allow equity accounting
or develop a process to estimate the fair value
at every reporting date.
An investment directly in the asset itself rather
than in an entity is sometimes used for certain
assets. The investment will not qualify as jointly
controlled assets if there is no joint control and
equity accounting or fair value accounting cannot
be applied if there is no entity. An undivided interest
should therefore be classified as a non-current
investment and carried at cost less accumulated
depreciation and accumulated impairment . This classification is similar to PPE but
differs in so far as the investor does not control
the underlying item of PPE.
An undivided interest in an asset is normally accompanied
by a requirement to incur a proportionate share
of the operating and maintenance costs of the asset.
These costs should be recognised as expenses in
the income statement when incurred and classified
in the same way as equivalent costs for wholly owned
assets.
Production sharing arrangements and concessions
There are as many forms of production sharing arrangements
(PSA) and concessions as there are combinations
of national, regional and municipal governments
in oil producing areas.
A PSA is the method whereby governments facilitate
the exploitation of their country's mineral resources
by taking advantage of the expertise of a commercial
oil and gas entity. Governments, particularly in
emerging nations, try to provide a stable regulatory
and tax regime to create sufficient certainty for
commercial entities to invest in an expensive and
long lived development process. An oil and gas entity
will undertake exploration, supply the capital,
develop the resources found, build the infrastructure
and lift the natural resources. The government retains
title to the mineral resources (whatever the quantity
that is ultimately extracted) and often the legal
title to all fixed assets constructed to exploit
the resources. The government will take a percentage
share of the output which may be delivered in product
or paid in cash under an agreed pricing formula.
The operating entity may only be entitled to recover
specified costs plus an agreed profit margin. It
may have the right to extract resources over a specified
period of time.
A concession agreement is much the same although
the entity will retain legal title to its assets
and does not share production with the government.
The government will still be compensated based on
production quantities and prices - this is often
described as a concession rent, royalty or a tax.
PSAs and concessions are not standard even with
the same legal jurisdiction. The more significant
a new field is expected to be, the more likely that
the relevant government will write specific legislation
or regulations for it. Each must be evaluated and
accounted for in accordance with the substance of
the arrangement. The entity's previous experience
of dealing with the relevant government will also
be important as it is not uncommon for governments
to force changes in PSAs or concessions based on
changes in market conditions or environmental factors.
An agreement may contain a right of renewal with
no significant incremental cost. The government
may have a policy or practice with regard to renewal.
These should be assessed when estimating the expected
life of the agreement.
The IFRIC has a long running discussion on concession
accounting that is expected to result in an interpretation
in 2005/2006. The interpretation will not be specifically
directed at PSAs and concession accounting but many
agreements may well be captured by it. Management should continue
to monitor developments as an interpretation might
force significant changes in accounting for concessions
and PSAs that resemble concessions.
Exploration, development and production assets
in PSAs
The legal form of the PSA or concession should
not impact the recognition of exploration and evaluation
(E&E) assets or production assets . Costs that meet the criteria of IFRS 6, IAS 38 or
IAS 16 should be recognised in accordance with the
usual criteria where the entity is exposed to the
majority of the economic risks and has access to
the probable future economic benefits of the assets.
The period of the PSA or concession should be longer
than the expected useful life of the majority of
the constructed assets. The probable mineral resources
and current prices should provide evidence that
E&E, development and fixed asset investment
will be recovered during the concession period.
Assets are appropriately recorded on the balance
sheet of the entity beyond the E&E phase, if
both conditions are present .
A PSA that is shorter than the expected useful
life of the related production assets or is a cost
plus arrangement can represent an arrangement whereby
the government compensates the entity for exploration,
development and construction of fixed assets. The
entity can continue to capitalise E&E and development
costs but fixed assets are not capitalised as such.
The entity instead may have a receivable from the
government where it is allowed to retain oil extracted
to the extent of costs incurred plus a profit margin.
The accounting applied in these circumstances is
therefore in accordance with IAS 39 rather than
IAS 16.
All assets recognised are then accounted for under
the usual policies of the entity for subsequent
measurement, depreciation, amortisation, impairment
testing and de-recognition. Assets should be fully
depreciated or amortised on a units-of-production
basis by the date that control passes back to the
government or the concession ends. A PSA is almost
always a separate CGU for impairment testing purposes
once in production .
Revenue and costs of PSAs and concessions
The entity should record only its share of oil
under a PSA as revenue. Oil extracted on behalf
of a government is not revenue or a production cost
. The entity acts as the government's
agent to extract and deliver the oil or sell the
oil and remit the proceeds. Many PSAs specify that
income taxes owed by the entity are paid in delivered
oil rather than cash. 'Tax oil' is recorded as revenue
and as a reduction of the current tax liability
to reflect the substance of the arrangement where
the entity delivers oil to the value of its current
tax liability .
Any volume based tax is accounted for as royalty
or excise tax within operating results .
Assets subject to depreciation, depletion or amortisation
should be expensed in a manner that reflects the
consumption of their economic benefits. The units-of-
production basis is usually the appropriate method
.
Concessions in utilities
Concessions in power and water utilities are found
as 'build, operate and transfer' (BOTs) or 'build,
own, operate and transfer' (BOOTs) arrangements.
The government will contract with an entity to construct
a substantial generating station, dam or transmission
network. The entity may use a sub-contractor for
the construction and then take control of the asset
or operate the asset for the government. These arrangements
must be evaluated in a similar way to the concessions
and PSAs described above. The accounting should
follow the economic substance of the arrangements.
Co-located assets
Power and water companies particularly may construct
generating or treatment facilities at customer locations
on property owned or controlled by the customer. This
occurs particularly where a customer is a heavy user
of power and steam or produces substantial waste water
requiring treatment before discharge. These arrangements
may also be found where the customer produces waste
by-products that can be burned to produce electricity.
These arrangements may have the substance of a
finance lease under IAS 17R.4 where the customer
has the majority of the risks and rewards incidental
to ownership of the asset [IFRIC4]. Some of the
characteristics consistent with a finance lease
are where the customer takes the majority of the
output and makes payments for the asset to 'stand
ready' in addition to payments for output received.
A common indicator of a finance lease is that the
customer provides a de facto guarantee of obligations
assumed to finance the facility. The guarantee may
take the form of a take or pay contract or an outright
guarantee of indebtedness.
Where the utility has other customers, such that
the majority of normal capacity production is sold
to third parties, the elements of a finance lease
are not usually present and the arrangement is accounted
for as owned generating assets.
Disclosures
There are specific and extensive disclosure requirements
associated with each of the topics above. The relevant
general chapters of Applying IFRS and the specific
standards should be consulted for all arrangements
that are present.
|
