Download Changes to joint venture accounting

IMPACT ON MINING COMPANIES
February 2012
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.
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.
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.
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How do the new rules for accounting
for joint arrangements differ from
current requirements?
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.
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.
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.
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.
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
JCE: Jointly controlled entity
2
JO: Joint operation
JV: Joint venture
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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.
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.
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.
© 2012 KPMG IFRG Limited, a UK company, limited by guarantee. All rights reserved.
3
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.
4
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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.
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
© 2012 KPMG IFRG Limited, a UK company, limited by guarantee. All rights reserved.
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.
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.
5
Legal form and contractual arrangements
Other facts and circumstances
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.
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.
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.
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.
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.
6
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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.
Other parties to a
joint operation
If significant influence exists, then choice
between cost or in accordance with IFRS 9/
IAS 39; otherwise, in accordance with IFRS 9/
IAS 39.
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.
© 2012 KPMG IFRG Limited, a UK company, limited by guarantee. All rights reserved.
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.
7
Read more about the new standard
For a more detailed understanding of the potential effect
of IFRS 11, read our publication First Impressions: Joint
arrangements.
Other KPMG publications
A detailed discussion of the general accounting issues
that arise from the application of IFRSs can be found in our
publication Insights into IFRS.
In addition to Insights into IFRS, we have a range of
publications that can assist you further, including:
• Impact of IFRS: Mining
• The Application of IFRS: Mining
• IFRS compared to US GAAP
• Illustrative financial statements for interim and annual
periods
• IFRS Handbooks, which include extensive interpretative
guidance and illustrative examples to elaborate or clarify
the practical application of a standard
• New on the Horizon publications, which discuss
consultation papers
• Newsletters, which highlight recent developments
• IFRS Practice Issue publications, which discuss specific
requirements and pronouncements
• First Impressions publications, which discuss new
pronouncements, including First Impressions:
Consolidated financial statements and First Impressions:
Production stripping costs.
• Disclosure checklist.
IFRS-related technical information is also available at
kpmg.com/ifrs.
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and financial reporting guidance and literature, visit KPMG’s
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Publication name: Impact on mining companies: changes to joint venture accounting
Publication number: 120314
Publication date: February 2012
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