ACCT3103 Advanced Financial Accounting - Accounting for Joint Arrangements

Control (AASB 10:7): An investor controls an investee when they have:

Power over the investee (AASB 10:10-14, App B9-54).
Exposure or rights to variable returns from involvement with the investee (AASB 10:15-16, App B55-B57).
Ability to use power over the investee to affect the amount of the investor’s returns (AASB 10:15-16, App B58-72).

Consolidation Process Recap:

Record parent and subsidiaries' financials line-by-line on the consolidation worksheet and aggregate the accounts.
Perform acquisition analysis to determine goodwill or gain on bargain purchase, eliminate the parent’s investment in each subsidiary, eliminate intra-group transactions, and calculate non-controlling interest (NCI).
Post consolidation adjusting entries to the consolidation worksheet & calculate balances.
Prepare group financial statements.

Classification of Equity Investments

Financial Assets: No special business relationship between investor and investee (dealt with in ACCT2110).
Investments Providing Influence/Control: Investments providing the power to exert control, joint control, or significant influence (subject of ACCT3103).

Joint Control and Joint Arrangements

Joint Control (AASB 11.7): The contractually agreed sharing of control of an arrangement, which exists only when decisions about the relevant activities require the unanimous consent of the parties sharing control.

Joint Arrangement (AASB 11.4): An arrangement of which two or more parties have joint control.

Joint Arrangement Characteristics

Joint arrangements are used across all sectors of the economy and on any scale because they can be an effective way to raise capital and spread risk.

According to AASB 11.5, a joint arrangement has the following characteristics:

The parties are bound by a contractual arrangement (see paragraphs B2-B4).
The contractual arrangement gives two or more of those parties joint control of the arrangement (see paragraphs 7–13).

Types of Joint Arrangements (AASB 11.6, 11.14)

A joint arrangement is either a joint operation or a joint venture.

An entity must determine the type of joint arrangement in which it is involved. Classification depends upon the rights and obligations of the parties to the arrangement.

Joint Operations

Definition (AASB 11.15): A joint operation is a joint arrangement whereby 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.

Characteristics:

Is not a legal entity.
Cannot own assets or incur liabilities.
Cannot run its own bank account.
Does not have permanent, separately reportable books of account.
Is recognised as an interest by the joint operators.

Joint Ventures

Definition (AASB 11.16): A joint venture is a joint arrangement whereby the parties that have joint control of the arrangement have rights to the net assets of the arrangement. Those parties are called joint venturers.

Characteristics:

Has a separate identity from its separate joint venturers (e.g. a partnership, trust or company).
Maintains its own books.
Is recognised as an investment by the joint venturers.

The only distinguishing feature from usual company, trust or partnership is the existence of the JV contract.

Difference Between Joint Venture (JV) and Joint Operation (JO)

Determined on more than just whether a separate legal vehicle is used (AASB 11.B19).

A joint arrangement in which the assets and liabilities relating to the arrangement are held in a separate vehicle can be either a joint venture or a joint operation.

AASB 11.B21: When parties structure a joint arrangement in a separate vehicle, they need to assess whether the legal form, terms of the contractual arrangement, and other relevant facts give them:

Rights to the assets and obligations for the liabilities (joint operation).
Rights to the net assets (joint venture).

Determining if Arrangement is JO vs JV

Does the legal form of the separate vehicle give the parties rights to the assets and obligations for the liabilities? YES = JO, NO = Next question.
Do the terms of the contractual arrangement specify that the parties have rights to the assets and obligations for the liabilities? YES = JO, NO = Next question.
Have the parties designed the arrangement so that its activities primarily aim to provide the parties with an output (i.e., the parties have rights to substantially all the economic benefits of the assets held in the separate vehicle)? YES = JO, NO = JV.

Substance Over Form (AASB 11.B24)

The assessment of rights and obligations conferred upon the parties by the legal form of the separate vehicle is sufficient to conclude that the arrangement is a joint operation only if the parties conduct the joint arrangement in a separate vehicle whose legal form does not confer separation between the parties and the separate vehicle (i.e., the assets and liabilities held in the separate vehicle are the parties’ assets and liabilities).

JV or JO? Why Does It Matter?

A joint operator must use the line-by-line method to account for its interest in a joint operation (AASB 11.20).

A joint venturer must recognise its interest in a joint venture as an investment and must account for that investment using the equity method in accordance with AASB 128 Investments in Associates and Joint Ventures.

Equity accounting is covered in the next seminar.

Focus will be on accounting for joint operations and application of the line-by-line method.

Characteristics of Joint Operations

Joint operations are:

Unincorporated and not partnerships.
Not an investment but an interest.
Interest shown via disclosures in the joint operators’ individual financial reports.
Provide legal flexibility and possibly taxation benefits to joint operators.
Allow individual joint operators to maintain the accounting policies in their own individual separate books of accounts.
Joint operators share output and related costs &/or view JO dedicated assets as tenants in common.
Joint operators do NOT share profit.

Elements of Joint Operations

Joint Operation Agreement: Usually a written contract setting out the rights and obligations of the joint operators as well as the objectives and duration of the joint operation, how the joint operation is to be managed, voting rights and the means of settling disputes. Often a ‘boiler plate’ contract where joint operations are prevalent.
Management Agreement: Joint Operations usually require a manager (which can be one of the joint operators). The management agreement sets out the manager’s powers, rewards and responsibilities.
Parties (Joint Operators): Parties to the joint operation agreement are known as joint operators. There must be at least 2 joint operators. Most joint operations have a small number of joint operators.
Contributions: Each joint operator contributes resources, which can take the form of cash, operating assets, intangible assets such as patented technology, or management skills. A joint operator’s contribution usually determines their share in the operation.
Joint Control: Joint control is the contractually agreed sharing of control of an arrangement, which exists only when decisions about the relevant activities require the unanimous consent of the parties sharing control (AASB 11.7). Although joint operators have overall control of the joint operation, the day-to-day operating decisions will usually be made by the joint operation manager. Must be aware of any agency/moral hazard issues.
Finite Life: The joint operation is often established to pursue a specific economic activity.

Joint Operator's Joint Operation Interest

The substance of the interests of joint operators and partners is the same although the legal rights differ.

Each partner or joint operator in an undertaking has an interest in the jointly controlled assets and liabilities of the undertaking.

The partner or joint operator cannot dispose of its ‘specified proportion’ without the consent of the others.

A partner or joint operator can control its specified interest in each asset, as well as its share of the output generated by the undertaking’s activity.

Advantages of Joint Operations

Effective means of pooling resources.
Cost and risk sharing.
Flexibility in legal requirements.
Individual liability and financing.
Opportunity for investment in foreign countries.

Compared to other joint entities (for example, a partnership) a joint operation:

Avoids the unlimited liability and mutual agency disadvantages of a partnership.
Removes the joint operators from joint and several liability for the debts of the joint operation.
In normal circumstances, a joint operator is not bound by the actions of its co-joint operators.

Accounting for Joint Operations

The joint operator shall recognise in both its separate and consolidated financial statements in relation to its interest in a joint operation:

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; and
Its expenses, including its share of any expenses incurred jointly.

Accounting Process

At the beginning of a financial year/JO, each joint operator provides inputs to the joint operation.

Throughout the year, the operators account for their contribution to the JO through the one line item, 'Interest in joint operation'.

Periodically, the joint operation manager supplies management accounts to the joint operators (JOMA).

The joint operation itself has no permanent financial accounts, and therefore cannot hold any financial account balances at the end of the year. All financial changes are therefore reflected in the books of the separate joint operators.

Income of a Joint Operation

Joint operation results may include items of revenue and expense – arising, for example, from the investment of surplus funds. In a joint operation, revenues and expenses are incidental to the operation and not the purpose of the operation (remember that joint operators share output).

If JO revenues and expenses are shared, ATO may deem a business exists, and will therefore try to tax the joint operation rather than the individual joint operators.

Key Terminologies

Individual Joint Operators’ Separate Books of Accounts: The accounting system of each of the operators, which will follow accounting policies that are optimal for each separate operator, which may be different from each other.
Joint Operation’s Management Accounts (JOMA): The account that records activities and movements in resources that occur during an accounting period. This account will be reduced to zero at the end of each accounting period, as all balances will have been allocated to the individual joint operators, and it is not permitted to have balances remaining in the JOMA at an accounting period end.
Tenants in Common: Once each individual joint operator has contributed to the joint operation, each becomes a tenant in common of all the contributions made, not just of its own. In other words, each individual joint operator has an ownership interest in every contributed asset and every liability incurred.
Depreciations: Quick reminder of cost accounting principles: Depreciation cannot be charged if production has not commenced.

Once production starts, depreciation is an operating/manufacturing overhead.

Needs to be allocated across all forms of output.

In joint operations, there is a choice as to where to initially account for depreciation: Either in the JO Management Accounts (JOMA) or in the individual joint operators’ separate books.