Accounting for interests in joint ventures Chapter 28 Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider

Learning objectives Understand what a joint venture is Understand that joint ventures are, for accounting purposes, to be classified as jointly controlled operations, jointly controlled entities, or as involving jointly controlled assets Be able to define a jointly controlled operation and be able to provide the necessary accounting entries in the books of the venturer to account for the venturer’s interest in a jointly controlled operation (Continues) Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider

Learning objectives (cont.) Be able to define a jointly controlled entity and understand that a venturer is to recognise its interest in a jointly controlled entity by using the equity method of accounting Be aware that some joint ventures involve simply the joint control of assets, and be able to provide the necessary accounting entries in the books of the venturer to recognise interests in jointly controlled assets Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider

Introduction to accounting for interests in joint ventures ‘Joint ventures’ defined in NZ IAS 31 ‘Interests in Joint Ventures’ as being under joint control (stronger than significant influence) No one entity usually has control of the joint venture—entities typically not considered to be subsidiaries of parent entity NZ IAS 31 released January 2005, supersedes SSAP-25 ‘Accounting for Interests in Joint Ventures and Partnerships’: due to very similar harmonisation NZ IAS 31 Addresses how to account for the venturer’s interest in a joint venture Does not address how the joint venture itself should prepare its own financial statements Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider

Joint ventures defined A contractual arrangement whereby two or more parties undertake an economic activity, which is subject to joint control Joint control is a requirement for an arrangement to be considered to constitute a joint venture for the purposes of NZ IAS 31 Joint control (NZ IAS 31, par. 3): The contractually agreed sharing of control over an economic entity, existing only when the strategic financial and operating decisions relating to the activity require the unanimous consent of the parties sharing control (the venturers) (Continues) Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider

Joint ventures defined (cont.) Further, under NZ IAS 31 (par. 9): The existence of a contractual arrangement distinguishes interests that involve joint control from investments in associates in which the investor has significant influence (see AASB 128). Activities that have no contractual arrangement to establish joint control are not joint ventures for the purposes of this standard (Continues) Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider

Joint ventures defined (cont.) The contractual arrangement between the parties to the joint venture establishes a number of issues, including the operation and management of the joint venture: Under NZ IAS 31 (par. 10): The contractual arrangement may be evidenced in a number of ways, for example by a contract between the venturers or minutes of discussions between the venturers. In some cases, the arrangement is incorporated in the articles or other by-laws of the joint venture (Continues) Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider

Joint ventures defined (cont.) NZ IAS 31 (par. 10) (cont.) Whatever its form, the contractual arrangement is usually in writing and deals with such matters as: the activity, duration, and reporting obligations of the joint venture; the appointment of the board of directors or equivalent governing body of the joint venture and voting rights of the venturers; capital contributions by the venturers; and the sharing by the venturers of the output, income, expenses or results of the joint venture NZ IAS 31 (par. 11) The contractual arrangement establishes joint control over the joint venture. Such a requirement ensures that no single venturer is in a position to control the activity unilaterally (Continues) Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider

Joint ventures defined (cont.) Classifications of joint ventures Jointly controlled entity A separate entity is formed to undertake joint activity Includes partnerships, trusts, incorporated entities Jointly controlled operation Involves shared use of assets, other resources and expertise of venturers, but no separate entity formed Joint controlled assets Involves the joint control by the venturers of one or more assets contributed to the joint venture (Continues) Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider

Joint ventures defined (cont.) Classification of joint ventures Accounting treatment required for a joint venture will depend on whether the joint venture is represented by: a jointly controlled operation jointly controlled assets a jointly controlled entity Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider

Jointly controlled operations Where jointly controlled operation exists the venturer must recogise the assets it controls, the liabilities and expenses it incurs and revenues from its share of the joint venture Jointly controlled operations (NZ IAS 31, par. 13) The operation of some joint ventures involves the use of assets and other resources of the venturers rather than the establishment of a corporation, partnership, or other entity or a financial structure that is separate from the venturers themselves. Each venturer uses it own property, plant and equipment and carries its own inventories. It also incurs its own expenses and liabilities and raises its own finance, which represents its own obligations. The joint venture activities may be carried out by the venturer’s employees alongside the venturer’s similar activities. The joint venture agreement usually provides a means by which the revenue from the sale of the joint product and any expenses incurred in common are shared among the venturers (Continues) Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider

Jointly controlled operations (cont.) Jointly controlled operations (NZ IAS 31, par. 14) An example of a jointly controlled operation is when two or more venturers combine their operations, resources and expertise to manufacture, market and distribute jointly a particular product, such as an aircraft. Different parts of the manufacturing process are carried out by each of the venturers. Each venturer bears its own costs and takes a share of the revenue from the sale of the aircraft, such share being determined in accordance with the contractual arrangement (Continues) Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider

Jointly controlled operations (cont.) The interests in joint venture operations must be recognised in the venturer’s own financial statements. NZ IAS 31 (par. 15): In respect of its interests in jointly controlled operations, a venturer shall recognise in its financial statements: the assets that it controls and the liabilities that it incurs; and the expenses that it incurs and its share of the income that it earns from the sale of goods or services by the joint venture (Continues) Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider

Jointly controlled operations (cont.) Further guidance concerning accounting for jointly controlled operations is offered in NZ IAS 31 (par. 16): Because the assets, liabilities, income and expenses are recognjsed in the financial statements of the venturer, no adjustments or other consolidation procedures are required in respect of these items when the venturer presents a consolidated financial report Further, NZ IAS 31 (par. 17) states: Separate accounting records might not be required for the joint venture itself and a financial report might not be prepared for the joint venture. However, the venturers may prepare management accounts so that they may assess the performance of the joint venture (Continues) Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider

Jointly controlled operations (cont.) Disclosure Disclosure requirements in relation to jointly controlled operations, as outlined in NZ IAS 31, are as follows: In respect of jointly controlled operations and assets, the venturer shall disclose the following information: the name and principal activities of each significant jointly controlled operation or asset; its percentage interest in the output of each significant jointly controlled operation or asset during the annual reporting period; and for each category of assets, the aggregate amount employed in jointly controlled operations or assets (Continues) Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider

Jointly controlled operations (cont.) Disclosure (cont.) Assets arising from a venturer’s share in the items employed in a jointly controlled operation are normally included in the venturer’s balance sheet with other assets that have a similar nature or function Liabilities incurred by a venturer as a result of its interest in a jointly controlled operation are included with other liabilities of the venturer that have a similar nature Method is referred to as ‘line-by-line’ method — assets in the balance sheet will include both assets controlled by the entity and those that have been contributed by the joint venture Refer to Worked Example 28.1, 'Accounting for a joint venture operation', pp. 1146–49 (Continues) Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider

Jointly controlled operations (cont.) Transfer of assets to joint venture Where venturers make contributions of assets to the joint venture, the value of the contribution is assessed at fair value Transfer of assets typically treated as a sale of the ownership proportion of the assets given up Where there is a difference between the book value and the fair value of the asset, this difference will typically be treated as a profit or loss on sale (Continues) Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider

Jointly controlled operations (cont.) Transfer of assets to joint venture (cont.) NZ IAS 31 (par. 48) states: When a venturer contributes or sells assets to a joint venture, recognition of any portion of a gain or loss from the transaction shall reflect the substance of the transaction. While the assets are retained by the joint venture, and provided the venturer has transferred the significant risks and rewards of ownership, the venturer shall recognise only that portion of the gain or loss that is attributable to the interests of the other venturers. The venturer shall recognise the full amount of any loss when the contribution or sale provides evidence of a reduction in the net realisable value of current assets or an impairment loss. Refer to Worked Example 28.2, 'Transfer of assets to a joint venture operation where book value and fair value differ', p. 1150 Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider

Jointly controlled assets Accounting treatment for jointly controlled assets is very similar to that required for jointly controlled operations NZ IAS 31 (par. 18): Some joint ventures involve the joint control, and often the joint ownership, by the venturers of one or more assets contributed to, or acquired for the purpose of, the joint venture and dedicated to the the purposes of the joint venture. The assets are used to obtain benefits for the venturers. Each venturer may take a share of the output from the assets and each bears an agreed share of the expenses incurred (Continues) Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider

Jointly controlled assets (cont.) NZ IAS 31 (par. 19): These joint ventures do not involve the establishment of a corporation, partnership or other entity, or a financial structure that is separate from venturers themselves. Each venturer has control over its share of future economic benefits through its share of the jointly controlled asset NZ IAS 31 (par. 20): Many activities in the oil, gas, and mineral extraction industries involve jointly controlled assets. For example, a number of oil production companies may jointly control and operate an oil pipeline. Each venturer uses the pipeline to transport its own product in return for which it bears an agreed proportion of the expenses of operating the pipeline. Another example of a jointly controlled asset is when two entities jointly control a property, each taking a share of the rents received and bearing a share of the expenses (Continues) Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider

Jointly controlled assets (cont.) Accounting requirements for jointly controlled assets (NZ IAS 31, par. 21): In respect of its interest in jointly controlled assets, a venturer shall recognise in its financial statements: Its share of the jointly controlled assets, classified according to the nature of the assets; any liabilities that it has incurred; its share of any liabilities incurred jointly with other venturers in relation to the joint venture any income from the sale or use of its share of the output of the joint venture, together with its share of any expenses incurred by the joint venture; and any expenses that it has incurred in respect of its interest in the joint venture (Continues) Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider

Jointly controlled assets (cont.) Note: Because the assets, liabilities, income and expenses are recognised in the financial statements of the venturer, no adjustments or other consolidation procedures are required in respect of these items when the venturer presents a consolidated financial report Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider

Joint venture entities Sometimes joint ventures are undertaken through an entity that has been separately established to undertake the activities concerned Jointly controlled entity defined (NZ IAS 31, par. 24): A joint venture that involves the establishment of a corporation, partnership or other entity in which each venturer has an interest. The entity operates in the same way as other entities, except that a contractual arrangement between the venturers establishes joint control over the economic activity of the entity NZ IAS 31 (par. 25): A jointly controlled entity controls the assets of the joint venture, incurs liabilities and expenses and earns income. It may enter into contracts in its own name and raise finance for the purposes of the joint venture activity. Each venturer is entitled to a share of the profits of the jointly controlled entity, although some jointly controlled entities also involve a sharing of the output of the joint venture (Continues) Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider

Joint venture entities (cont.) Accounting records required of a jointly controlled entity (NZ IAS 31, par. 28): A jointly controlled entity maintains its own accounting records and prepares and presents a financial report in the same way as other entities in conformity with New Zealand equivalents to IFRSs NZ IAS 31 requires a venturer to account for its interest in a jointly controlled entity using the equity method of accounting (Continues) Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider

Joint venture entities (cont.) NZ IAS 31 (par. 38): A venturer shall recognise its interest in a jointly controlled entity using the equity method A venturer that prepares consolidated financial reports will recognise its investment in a joint venture entity by using the equity method in its consolidated reports (and recording the investment at cost, or at a recoverable amount, in its own financial report). A venturer that is not required to prepare a consolidated financial report will recognise its investment in the associate by using the equity method of accounting in its own financial report Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider

Disclosure requirements Disclosure requirements of NZ IAS 31 depend on whether the joint venture is classified as: a jointly controlled operation jointly controlled assets a jointly controlled entity (refer to pars Aus 57.2 – 5) Contingent liabilities and other commitments There are requirements to separately disclose information about contingent liabilities and other commitments that relates to a joint venture regardless of whether it is a jointly controlled entity, jointly controlled operation, or involves jointly controlled assets Disclosure requirements are addressed in NZ IAS 31, pars 54 and 55 Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider

Summary Joint ventures can be classified as: jointly controlled assets jointly controlled operations jointly controlled entities Accounting approaches dependent on classification Jointly controlled operations—joint ventures that involve the shared use of assets of the venturers rather than the establishment of a corporation, partnership or other form of entity or a financial structure that is separate from the venturers themselves Jointly controlled operation—established by the venturers to obtain individual benefits as opposed to joint or collective profitability, i.e. each venturer derives a share of output from the joint venture operation rather than necessarily shared revenue or profit (Continues) Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider

Summary (cont.) Jointly controlled entity—a joint venture that involves the establishment of a corporation, partnership, or other entity in which each venturer has an ownership interest Where an entity has an interest in a jointly controlled operation, the venturer must recognise the assets within the joint venture that it controls, the liabilities and expenses that it incurs in relation to the joint venture and revenues from its share of the output of the joint venture Where the joint venture is a jointly controlled entity, the equity method of accounting must be applied in the consolidated accounts of the parent entity and the cost method applied in its own financial reports or, if the venturer does not prepare consolidated accounts, the equity method is to be used in the accounts of the venturer itself Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider