IFRS 11: Accounting for Joint Arrangements

International Financial Reporting Standard 11 (IFRS 11) provides the framework for the financial reporting of interests in joint arrangements. The standard’s objective is to establish principles for all entities party to a jointly controlled arrangement, ensuring their financial statements faithfully represent the economic substance of their involvement. IFRS 11 applies to all parties of a joint arrangement to bring consistency and transparency to how these business structures are reported. By setting forth specific criteria, the standard guides professionals in assessing their rights and obligations, which is fundamental to determining the correct accounting treatment.

Identifying a Joint Arrangement

A joint arrangement under IFRS 11 is defined by two characteristics: a contractual arrangement and joint control. The contractual arrangement forms the operational backbone of the collaboration and is evidenced by a formal contract or other documented communications that create enforceable rights and obligations. This agreement outlines the terms under which the parties will undertake the activity together.

The main element is establishing “joint control,” which is the contractually agreed sharing of control over an arrangement. This condition is met only when decisions about the “relevant activities”—those that significantly affect the arrangement’s returns—require the unanimous consent of all parties sharing control. If any one party can direct the relevant activities without the consent of the others, joint control does not exist.

For instance, if two companies form an entity and the agreement requires both to approve production levels and sales contracts, joint control exists. Entities must continuously re-evaluate for joint control if facts and circumstances change.

Classifying the Type of Joint Arrangement

Once an arrangement is identified as having joint control, it must be classified as either a joint operation or a joint venture. This classification hinges on an assessment of the parties’ rights and obligations arising from the arrangement and dictates the accounting method to be applied.

A joint operation is an arrangement where the parties, known as joint operators, have rights to the specific assets and obligations for the specific liabilities relating to the arrangement. The parties are involved in using their own assets and incurring their own liabilities, often sharing the output of the activity rather than the profit.

In contrast, a joint venture is an arrangement where the parties, or joint venturers, have rights to the net assets of the arrangement. This means their interest is in the performance of the entity as a whole, represented by the residual value of its assets after deducting all liabilities. Joint ventures are often structured through a separate legal entity, which legally separates the arrangement’s assets and liabilities from the parties involved.

The classification process requires analyzing the arrangement’s structure. If an arrangement is not structured through a separate vehicle, it is a joint operation. If it is, further analysis of the legal form, contractual terms, and other facts is necessary. For example, if contractual terms specify that the parties are entitled to substantially all of the economic benefits of the assets, it points towards a joint operation even if a separate vehicle exists.

Accounting for Joint Operations

The accounting for a joint operation reflects the direct interest that a joint operator has in the assets, liabilities, revenues, and expenses of the arrangement. An entity must recognize its specific share of these items directly in its own financial statements, integrating the activities on a line-by-line basis.

In practice, this means a joint operator will recognize its share of any property, plant, and equipment used in the operation, alongside its own. It will also account for its portion of any liabilities incurred and recognize its share of the revenue generated from the sale of the output and its share of the expenses incurred.

For example, if two construction companies jointly build a bridge, each would recognize its share of the construction work-in-progress as an asset and its share of any project-specific debt as a liability. When the project generates revenue, each company reports its contractual share on its income statement.

Accounting for Joint Ventures

The accounting for an interest in a joint venture follows a single method. IFRS 11 mandates the use of the equity method, as detailed in IAS 28. This approach treats the investment in the joint venture as a single line item in the statement of financial position, reflecting the investor’s interest in the net assets of the venture.

Under the equity method, the investment is initially recorded at its cost. Subsequently, the carrying amount of this investment is adjusted in each reporting period to reflect the joint venturer’s share of the joint venture’s profit or loss.

If the joint venture reports a profit, the venturer increases the carrying amount of its investment; if it reports a loss, the carrying amount is decreased. Any distributions received from the joint venture, such as dividends, are not treated as revenue. Instead, these distributions are considered a return on the investment and reduce the carrying amount of the investment on the balance sheet.

Required Financial Statement Disclosures

To provide users of financial statements with a clear understanding of an entity’s involvement, IFRS 12 sets out specific disclosure requirements. The goal is to enable an evaluation of the nature, extent, and financial effects of these interests.

An entity must disclose significant judgments and assumptions made in determining that it has joint control over an arrangement. For each material joint arrangement, detailed information is required, including its name, principal place of business, and the proportion of ownership interest held by the entity.

For joint ventures that are material, the entity must provide summarized financial information. This includes figures such as:

• Cash and cash equivalents
• Current and non-current assets
• Current and non-current liabilities
• Revenue
• Profit or loss from continuing operations

These disclosures give investors and analysts insight into the financial health and performance of the joint venture, which is not otherwise visible through the single-line equity method.