financial repor ting joint venture

8/14/2019 Financial Repor Ting Joint Venture

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Background

In this months issue I am going to cover the topic of joint venture accounting, a subject which is currentlyunder review by the International Accounting StandardsBoard (IASB) and is likely to be altered in the next fewmonths once the current exposure draft is implemented.

IAS 31 was published in December 2003 andprovides guidance on how to account for joint ventures.

A joint venture is defined by IAS 31 as a contractualagreement whereby two or more parties undertake aneconomic activity which is subject to joint control. Jointcontrol represents a contractually agreed sharing ofcontrol over an economic activity. A classic example ofthis arrangement is the Airbus operation in Toulousewhich is jointly controlled by British Aeropace Plc andfour other joint venturers, all of which have toconsensually agree before any major operating decisionis undertaken.

There are two different accounting methods permittedby the standard:

Proportionate consolidation

This is a method of accounting and reporting whereby aventurers share of each of the assets, liabilities, incomesand expenses of a jointly controlled entity are combinedon a line-by-line basis with similar items in the venturersfinancial statements or reported as separate line items.

Equity methodInitially the investment is carried at cost by a venturerand adjusted thereafter for the post acquisition changein the venturers share of net assets of the jointly

controlled entity. The income statement reflects theventurers share of results of operations of the jointlycontrolled entity.

IAS 31 at present favours proportionate consolidationbut permits equity accounting as an acceptable secondbest solution when accounting for jointly controlledentities.

IAS 31 identifies three broad types of joint ventureactivity:

* jointly controlled operations

* jointly controlled assets; and

* jointly controlled entities

They all have the common characteristics of havingtwo or more joint venturers bound under contract andestablishing joint control.

Jointly Controlled Operations

Some joint ventures involve the use of assets andother resources rather than the establishment of acorporation, partnership or other entity. Each ventureruses its own assets and incurs its own expenses andraises its own finance.

The joint venture agreement usually provides a meansby which revenue from the sale of the joint product andany expenses are shared among the venturers. An

example might be a joint venture to manufacture,market and distribute jointly a particular product such asan aircraft. Different parts of the manufacturing processare carried out by each of the venturers and eachventurer takes a share of the revenue from the sale ofthe aircraft but bears its own costs.

A venturer should recognise in its financial statementsthe following:

(a) the assets it controls and the liabilities it incurs; and

(b) the expenses it incurs and its share of the income itearns from the sale of goods or services by the jointventure.

J o i n t Ve n t u r e A c c o u n t i n g o n t h e M o v e

Robert Kirk outlines the requirements of IAS 31.

Financia l Report ing Joint Venture


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Financia l Report ing Joint Ventur

Effectively an entity is adopting proportionate consolidationfor such relationships.

Jointly Controlled Assets

Some joint ventures involve joint control by the venturersover one or more assets which are dedicated for thepurposes of the joint venture. Each venturer may take ashare of the output and bear an agreed share of theexpenses incurred.

No corporation, however, is established. Many activities inoil and gas and mineral extraction involve jointly controlledassets e.g. an oil pipeline. Another example is the jointcontrol of property, each taking a share of the rents receivedand bearing a share of the expenses.

Again, a venturer should recognise in its financialstatements:

(a) its share of jointly controlled assets, classified accordingto their nature;

(b) any liabilities it has incurred;

(c) its share of any liabilities jointly incurred with otherventurers;

(d) any income from the sale or use of the share of theoutput of the joint venture together with its share ofany expenses incurred;

(e) any expenses incurred re its interest in the jointventure.

The treatment of jointly controlled assets should reflecttheir substance and economic reality and usually the legalform of the joint venture. Separate accounting records forthe joint venture may be limited to those expenses incurredin common. Financial statements may not be prepared forthe joint venture but management accounts may be

needed to assess performance.

Jointly Controlled Entities

The main type of joint venture is a jointly controlled entity.In this case a corporation is established and operates as perother legal entities except that there is a contractualarrangement between the venturers that establishes jointcontrol over the economic activity of the entity.

A jointly controlled entity controls the assets of the jointventure, incurs liabilities and expenses and earns income. Itmay enter contracts in its own name and raise finance foritself and each venturer is entitled to a share of the resultsof the jointly controlled entity.

An example is when two entities combine their activitiesin a particular line of business by transferring relevant assets

and liabilities into a jointly controlled entity or it could be joint venture by establishing a joint entity with a foreigovernment.

In substance they are often similar to jointly controlloperations or jointly controlled assets. However, it domaintain its own accounting records and prepares financial statements in the same way as other normentities in conformity with appropriate national regulation

Each venturer usually contributes cash or other resourcto the jointly controlled entity. These contributions aincluded in the accounting records of the venturer anrecognised in its financial statements as an investment the jointly controlled entity.

Financial Statements of a Venturer

Under IAS 31, a venturer should report its interest injointly controlled entity using one of two reporting formafor proportionate consolidation or using the equity metho

It is essential that a venturer reflects the substance aeconomic reality of the arrangement. The application

proportionate consolidation means that the consolidatebalance sheet of the venturer includes its share of tassets it controls jointly and its share of the liabilities fwhich it is jointly responsible. The consolidated incomstatement includes the venturers share of the income aexpenses of the jointly controlled entity. Many of tprocedures are similar to consolidation procedures set oin IAS 27.

There are different reporting formats to give effect proportionate consolidation but the most popular is combine a venturers share of each of the assets, liabilitieincome and expenses of the jointly controlled entity wsimilar items in the consolidated statements on a line

line basis. e.g. its share of inventory with inventory of thconsolidated group.

Proportionate consolidation can only be adopted frothe date the entity acquires joint control and it should discontinued from the date on which it ceases to have jocontrol over a jointly controlled entity. This could happewhen the venturer disposes of its interest or when externrestrictions mean that it can no longer achieve its goals.

As an alternative, a venturer may report its interest injointly controlled entity using the equity method as per I28 Accounting for associates. The equity method supported by those who argue that it is inappropriate combine controlled items with jointly controlled item

Originally, the standard took the view that it should nrecommend the use of the equity method becauproportional consolidation better reflects the substanand economic reality of a venturers interest in a joincontrolled entity. However, the latest exposure dr(October 2007) has now decided to recommend tdemise of proportionate consolidation and has opted fequity accounting only. As with proportionate consolidatia venturer should discontinue the use of the equity methfrom the date it ceases to have joint control.

An example of both approaches is provided on thfollowing page:

Proportionate consolidation can only beadopted from the date the entity acquires jointcontrol and it should be discontinued from the

date on which it ceases to have joint controlover a jointly controlled entity.


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Suggested solution Castlerock Plc

How should the investment in Castlerock plc be treated in the consolidatedbalance sheet and income statement?

Equity Accounting

The investment should be disclosed as a single line under IAS 31, if

adopting equity accounting, as follows:

Calculation of goodwill

At 1 January 2007 fair value of assets

m

Property, plant and equipment 30

Current assets 31

Current liabilities (20)

Non current liabilities (8)

33

Shareholding 30% x 33m 9.9

Fair value of investment 14

Goodwill (bal fig.) 4.1

m

Disclosure in balance sheet (Extract)

Cost of investment 14

Post-acquisition profits 3.930% x (32m10m share capital - 9m retained reserves)

Additional depreciation charge (1.2)(2 years x 20% x (30m fair value 20m cost)) x 30%

Investment in joint venture 16.7

Alternative disclosure

Share of net assets 36

(46m10m share of inventory profits)

Revaluation of property, plant and equipment 10

Additional depreciation (4)

(10m x 20% x 2 years)42

Shareholding 12.6(30% x 42m)

Share of goodwill 4.1

Investment in joint venture 16.7

The alternative disclosure is more correct since it doesnot disclose any element of profit as part of the investment.

Disclosure in the income statement (Extract)m

Share of operating profit in joint venture 5.1

(30% x 29m 3m inter-co. profit - 0.6.m depreciation)

Exceptional item joint venture (3.0)(30% x 10m)

Finance costsjoint venture (1.2)

(30% x 4m)

Tax on profit on ordinary activities of Joint venture (0.9)

(30% x 3m)

Example Castlerock Plc

The following financial statements relate toCastlerock, a public limited company.

Income Statement for year ended31 December 2007

m m

Turnover 212

Cost of sales (170)Gross profit 42

Distribution costs 17

Administration expenses 8 (25)

17

Other operating income 12

29

Exceptional item (10)

Finance costs (4)

Profit on ordinary activities before tax 15

Income tax (3)

12

Balance Sheet at31 December 2007 m m

Non current assets

Property, plant andequipment 30

Goodwill 7

37

Current assets 31

Current liabilities (12)

Net current assets 19

Total assets less current labilities 56

Non current liabilities (10)

46

Equity and reserves

Called up share capital

Ordinary share capital 10Share premium account 4

Retained profits(36 4 dividend paid) 32

46

(i) Castlederg, a public limited company, acquired 30 per cent of the ordinaryshare capital of Castlerock Plc at a cost of 14 million on 1 January 2006.The share capital of Castlerock has not changed since acquisition when theretained profit of Castlerock was 9 million. Two other venturers each own35% of the entity and all three have joint control over the operating activitiesof the investee.

(ii) At 1 January 2006 the following fair values were attributed to the net assets ofCastlerock Plc but not incorporated in its accounting records.

m

Property, plant andequipment 30 (carrying value 20m)

Goodwill (estimate) 10

Current assets 31

Current liabilities 20

Non current liabilities 8

(iii)During the year to 31 December 2007, Castlerock sold goods to Castlederg tothe value of 35 million. The inventory of Castlederg Plc at 31 December2007 included goods purchased from Castlerock Plc on which the companymade a profit of 10 million.

(v) The policy of all companies in the Castlederg group is to depreciate tangiblefixed assets at 20 per cent per annum on the straight-line basis.


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Financia l Report ing Joint Ventur

Transactions between a Venturer and aJoint Venture

When a venturer contributes or sells assets to a jointventure, recognition of any portion of a gain or lossshould reflect the substance of the transaction. While theassets are retained by the joint venture and provided theventurer has transferred the significant risks and rewardsof ownership, the venturer should recognise only thatportion of the gain or loss which is attributable to theinterests of the other venturers. The venturer should

recognise the full amount of any loss when the saleprovides evidence of a reduction in the NRV of currentassets or an impairment loss.

When a venturer purchases assets from a joint venturethe venturer should not recognise its share of the profitsof the joint venture until it resells the assets to anindependent party. A venturer should recognise its shareof the losses in the same way as profits except the lossesshould be recognised immediately when they representa reduction in the NRV of current assets or animpairment loss under IAS 36.

Disclosure

Under IAS 31, a venturer should disclose the aggregaamount of the following contingent liabilities, unless tprobability of loss is remote, each separately:

(a) any contingent liabilities incurred in relation to interest in joint ventures and its share in each contingeliability incurred jointly with other venturers;

(b) its share of contingent liabilities of the joint venturfor which it is contingently liable; and

(c) those contingent liabilities that arise because tventurer is contingently liable for the liabilities of tother venturers of a joint venture.

Items (a) to (c) should be disclosed separately.

A venturer should also disclose the aggregate amountthe following commitments regarding interests in joventures separately from other commitments:

(a) any capital commitments re joint ventures and share in capital commitments incurred jointly with oth

venturers; and(b) its share of capital commitments of the joint venturthemselves.

A venturer should disclose a listing and description interests in significant joint ventures and the proportioof ownership interest held in jointly controlled entitieAn entity that adopts line by line reporting fproportionate consolidation or the equity method shoudisclose the aggregate amounts of each of its curreassets, long-term assets, current liabilities, long-terliabilities, income and expenses related to interests

joint ventures.

A venturer that does not publish consolidat

accounts, because it has no subsidiaries, should disclothe above information as well.

Two excellent examples of good disclosure in Irelaare provided by McInerney Property Holdings Plc aUTV Plc, the former adopting equity accounting and thlatter proportionate consolidation.

McInerney Property Holdings Plc Yearended 31st December 2006

Interests in Joint VenturesA joint venture is a contractual arrangement where

the Group and other parties undertake an econom

activity that is subject to joint control and the strategfinancial and operating policy decisions relating to tactivities of the joint venture require the unanimoconsent of the parties sharing control.

Joint venture arrangements that involve testablishment of a separate entity which each venturhas an interest are referred to as jointly controllentities. The Group reports its interests in joincontrolled entities using the equity method. The namount of the Groups share of the assets and liabilitiof jointly controlled entities is disclosed in thconsolidated balance sheet as Interests in Joint Venture

Proportionate consolidation

If Castlederg adopted proportionate consolidation the following would be recorded:

Consolidated income statement

m

Consolidated income statement (Extract)

Turnover: Group and share of joint ventures X + 53.1

(212m gross less inter-company turnover 35m x 30%)Cost of sales(170m less inter company turnover 35m plus inter co profit10m x 30% + depreciation 0.6m) X + ( 44.1)

Distribution costs(17m x 30%) X + ( 5.1)

Administration expenses(8m x 30%) X + ( 2.4)

Other operating income(12m x 30%) X + 3.6

Exceptional items(10m x 30%) X + (3.0)

Finance costs(4m x 30%) X + (1.2)

Taxation(3m x 30%) X + (0.9)

Consolidated balance sheet (Extract)

Property etc X + 12.9

(37m + 10m revaluation4m additional depreciation= 43m x 30%)

Current assets X + 6.3

(31m 10m inter-company profit on stocks = 21m x 30%)

Goodwill X + 4.1

Current liabilities X + (3.6)

(12m x 30%)

Non current liabilities X + (3.0)

(10m x 30%)

Net assets X + 16.7

X: Denotes Castlederg Plc results for the year


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The Groups share of the profits and losses after interest and tax of jointlycontrolled entities is disclosed as Share of Results from Joint Ventures inthe consolidated income statement.

Any goodwill arising on the acquisition of the Groups interest in a jointlycontrolled entity is accounted for in accordance with the Groupsaccounting policy for goodwill (see below). Where the Group transactswith its jointly controlled entities, unrealised profits and losses areeliminated to the extent of the Groups interest in the joint venture.

Interests in Joint Ventures

The Group has a number of joint venture entities which are used tofinance specific projects. A list of all significant joint ventures, including thename, country of incorporation, proportion of ownership and nature ofoperations, is provided in note 46 on page 77.

Details of land commitments held in joint ventures are provided in note

41.

UTV Plc Year ended 31st December 2006

Investment in joint venture

A joint venture is an entity in which the Group holds an interest undera contractual arrangement where the Group and one or more otherparties undertake an economic activity that is subject to joint control.

The Groups interest in its joint ventures is accounted for byproportionate consolidation, which involves recognising a proportionateshare of the joint ventures assets, liabilities, income and expenses withsimilar items in the consolidated financial statements on a line-by-linebasis. The reporting dates of the joint venture and the Group are identical

and both use consistent accounting policies.

Aggregate amounts relating to Joint Ventures included in non-current assets:

2006 2005000 000

Total Assets 99,125 74,153

Total Liabilities (91,693) (62,867)

Total Net Assets 7,432 11,286

Net Interest in Joint Ventures 3,877 4,660

Attributable to Joint Ventures:

2006 2005000 000

Revenue 1,268 978

Operating costs (988) (1,011)

Finance income 15 3

Profit / (loss) before tax 295 (30)

Taxation (6) (1)

Profit / (loss) for the year 289 (31)

Current assets 546 365

Current liabilities 156 106

Non-current liabilities - -

Aggregate amounts relating to Joint Ventures included in IncomeStatement:

2006 2005000 000

Revenue 15,895 2,864

Expenses (14,098) (2,940)

Profit / (Loss) 1,747 (76)

Groups Share of Profit / (Loss) 1,064 (21)

Investments (continued)

(c) Joint Ventures

During the year ended 31 December 2006 there were two venture companies, First Radio Sales Limited and Digital Space Lim(2005: Absolute Radio (UK) Limited, Digital Space Limited andRadio Sales Limited). The revenue, expenditure, asset and liainformation relating to those joint ventures proportionately consolidin the Group accounts is disclosed below.

The latest developments - ED 9 JointArrangements (September 2007)

In September 2007 the IASB issued an exposure draft ED 9 Arrangements in which it proposes to eliminate the proportioconsolidation option.

ED 9 sets out requirements for recognition and disclosure of interejoint arrangements. Its objective is to enhance the faithful representof joint arrangement and it achieves this by requiring an entity:

(a) to recognise its contractual rights and obligations arising from itsarrangement. The precise form of arrangement is no longer the significant factor in determining the appropriate accounting treatm

and

(b) to provide enhanced disclosures about its interest in arrangements.

It forms part of the short term convergence project currently bundertaken by the IASB and American Financial Accounting StanBoard (FASB) and will lead to current IAS 31 being superceded.

Main features of ED 9

The core principle of ED 9 is that all parties to a joint arrangement shrecognise their contractual rights and obligations arising from the arrangement.

The definitions are similar to IAS 31 in that a joint arrangementcontractual arrangement whereby two or more parties undertakeconomic activity together and share decision making relating toactivity. There are still three types joint operations, joint assets andventures.

ED 9 requires a party to recognise its contractual rights and obligatioassets and liabilities. Contractual rights to individual assets and contraobligations for expenses represent interests in joint operations or assets.

The major recommendation is that an interest in a joint venture musthe equity method.

ED 9 also requires disclosure of a description of the nature of operait conducts through joint arrangements as well as a description of

summarised financial information relating to its interests in joint vent

Conclusion

The latest exposure draft will certainly force many listed Irish compto readdress the subject of joint venture accounting. A large numbcompanies such as UTV Plc have switched over from adopting eaccounting to proportionate consolidation on first adoptiointernational financial reporting standards but this process will inevhave to be reversed in the next two years. At this stage we are notwhen the revised standard will be published but is unlikely it wouladopted for any entities reporting before the end of 2009.

Robert Kirk is a Professor of Financial Reporting at the UniversUlster.

financial repor ting joint venture

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