What Was International Accounting Standard 31?

International Accounting Standard 31 (IAS 31) provided the guidance for how companies should account for their interests in joint ventures. First effective in 1992, this standard was a component of international financial reporting for over two decades. It is important to note that IAS 31 is no longer in effect. The International Accounting Standards Board (IASB) superseded it with IFRS 11 Joint Arrangements, which became mandatory for all annual reporting periods beginning on or after January 1, 2013.

Defining Joint Ventures Under the Standard

Under IAS 31, the defining characteristic of a joint venture was the presence of “joint control.” This was the contractually agreed sharing of control over an economic activity, not merely shared influence. An element of this definition was the requirement for unanimous consent from the parties sharing control, known as venturers, for strategic financial and operating decisions. If one party could unilaterally direct the activity, joint control did not exist.

The standard identified three distinct forms that a joint venture could take:

• Jointly controlled operations, where venturers used their own assets and incurred their own expenses and liabilities while also sharing in the revenue from the joint activity. An example would be two companies each using their own manufacturing plants to produce components for a shared final product.
• Jointly controlled assets, which involved the joint control and often joint ownership of one or more assets contributed to or acquired for the venture. Each venturer would take a share of the output from the assets and bear a share of the incurred expenses.
• Jointly controlled entity, which involved the establishment of a separate legal entity, such as a corporation or partnership, in which each venturer held an interest. This entity would control its own assets, incur its own liabilities and expenses, and earn its own income.

Prescribed Accounting Methods

When a company engaged in a jointly controlled entity, IAS 31 permitted two different methods for accounting for its interest. The preferred treatment was proportionate consolidation. This method required the venturer to combine its share of the joint venture’s assets, liabilities, income, and expenses with its own, on a line-by-line basis. To illustrate, if a company held a 40% interest in a jointly controlled entity that had $1 million in assets and $600,000 in liabilities, the venturer would add $400,000 to its own assets and $240,000 to its own liabilities on its balance sheet.

As an alternative, IAS 31 allowed for the use of the equity method. Under this approach, the investment in the jointly controlled entity is initially recorded at cost. This investment is then adjusted each period for the venturer’s share of the joint venture’s post-acquisition profits or losses. The venturer’s share of the profit or loss is shown as a single line item in the income statement. If the venture earned a profit of $100,000, the venturer would increase the value of its investment account by $40,000 and recognize that same amount as income.

Supersession and Replacement by IFRS 11

International Financial Reporting Standard 11 (IFRS 11), Joint Arrangements, officially replaced IAS 31. The motivation for replacing the standard was to address perceived weaknesses, particularly the focus on legal structure over economic substance and the accounting options that reduced comparability between companies.

A change introduced by IFRS 11 was the reclassification of joint arrangements. Instead of focusing on the legal form, the new standard requires an assessment of the parties’ contractual rights and obligations. This resulted in two new classifications: “joint operations” and “joint ventures.” A joint operation gives the parties rights to the assets and obligations for the liabilities, while a joint venture gives the parties rights to the net assets of the arrangement.

Arrangements that were previously “jointly controlled operations” or “jointly controlled assets” under IAS 31 generally became “joint operations” under IFRS 11, with similar accounting treatment where the operator recognizes its share of assets, liabilities, revenues, and expenses. The most significant change, however, affected arrangements classified as “joint ventures” under the new standard.

IFRS 11 eliminated the option for proportionate consolidation for all arrangements classified as joint ventures. It mandates the use of the equity method for these interests, removing the choice that existed under IAS 31. This change was driven by the view that proportionate consolidation was inconsistent with the definition of a joint venture, where the venturer has an interest in the net assets of the entity, not the individual assets and liabilities. By requiring a single method, the IASB aimed to enhance comparability for investors.