The International Accounting Standards Board has amended International Financial Reporting Standard (IFRS) 11, Joint Arrangements, to provide specific guidance on accounting for the acquisition of an interest in a joint operation (‘JO’) that is a business. The amendments address diversity in practice related to the accounting for these transactions.
A joint arrangement is a contractual arrangement where at least two parties agree to share control over the activities of the arrangement. Unanimous consent towards decisions about relevant activities between the parties sharing control is a requirement in order to meet the definition of joint control.
Joint arrangements can be joint operations or joint ventures. The classification is principle based and depends on the parties’ exposure in relation to the arrangement.
When the parties’ exposure to the arrangement only extends to the net assets of the arrangement, the arrangement is a joint venture.
Joint operators have rights to assets and obligations for liabilities. Joint operations are often not structured through separate vehicles.
When a joint arrangement is separated from the parties and included in a separate vehicle, it can be either a joint operation or a joint venture. In such cases, further analysis is required on the legal form of the separate vehicle, the terms and conditions included in the contractual agreement and sometimes, other facts and circumstances. This is because in practice, the latter two can override the principles derived from the legal form of the separate vehicle.
Joint operators account for their rights to assets and obligations for liabilities. Joint ventures account for their interest by using the equity method of accounting.
What is the issue?
Different accounting practices have been observed for the acquisition of interests in jointly controlled operations or jointly controlled assets. Arrangements that were formerly ‘jointly controlled operations’ and ‘jointly controlled assets’ in International Accounting Standard (IAS) 31, Interests in Joint Ventures, are JO in IFRS 11
Some preparers accounted for acquisition of interests in joint operations which constitute a business by applying the principles in IFRS 3, Business Combinations. Some preparers account for such acquisition using a cost approach by allocating the entire cost of acquisition to the identifiable asset. Some preparers applied the principles of IFRS 3 and other IFRSs in accounting for the acquisition.
The different approaches in the acquisition of interests in JO have led to different accounting outcomes, in particular:
The IASB noted that the diversity in practice resulted from the fact that IAS 31, which was superseded by IFRS 11, did not give specific guidance on the accounting for acquisitions of interests in JO, the activity of which constitutes a business, as defined in IFRS 3.
What is the amendment?
The amendments require an investor to apply the principles of business combination accounting under IFRS 3 when it acquires an interest in a JO that constitutes a ‘business’ (as defined in IFRS 3).
Specifically, an investor will need to:
All other principles of business combination accounting applies unless they conflict with IFRS 11.
The amendments are applicable to both the acquisition of the initial interest in a JO and the acquisition of additional interest in the same JO. However, a previously held interest is not remeasured when the acquisition of an additional interest in the same JO results in retaining joint control.
The amendments will apply to the acquisition of an interest in an existing JO that is a business, or when a JO is formed and an existing business is contributed. However the amendments do not apply when the formation of the JO coincides with the formation of a business. Transactions between an investor and a JO under common control are also excluded. The amendments require the disclosure of information specified in IFRS 3 and other IFRSs for business combinations.
We expect that this amendment to IFRS 11 would also be adopted in the Philippines and shall be effective for annual periods beginning on or after 1 January 2016 will be applied prospectively. Earlier adoption of the amendment may also be permitted. Transactions before the adoption date are grandfathered. The scope of the business combination exemption in PFRS 1, First-time adoption of Philippine Financial Reporting Standards, has been expanded to include the acquisition of an interest in JOs that are businesses.
Joint arrangements are frequently used as the most effective method for multi-nationals to access emerging markets, and those reporting entities may be similarly affected. The change required by the amendments is likely to increase the pressure on the definition of ‘what is a business’ and classification of joint arrangements under PFRS 11.
Assurance Partner, Ethics and Business Conduct Leader, PwC Philippines
Tel: +63 (2) 8459 3063
Carlos Federico C. de Guzman
Assurance Partner, PwC Philippines
Tel: +63 (2) 8845 2728