Accounting for joint arrangements and associates Joint World Bank and IFRS Foundation ‘train the trainers’ workshop hosted by the ECCB, 30 April to 4 May 2012

IFRS 11 Joint Arrangements MW © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Introduction 3 IFRS 11 Joint Arrangements establishes principles for financial reporting by parties to a joint arrangement. The standard must be applied by all entities who are party to a joint arrangement. MW © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Principle IFRS 11 establishes a principle-based approach for the 4 IFRS 11 establishes a principle-based approach for the accounting for joint arrangements: Parties to a joint arrangement recognise their rights and obligations arising from the arrangement, regardless of its structure or legal form Information about those rights and obligations assists users to better assess the prospects for future net cash inflows to the entity which is useful in making decisions about providing resources to the entity. © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Application of the principle 5 Parties that have rights to the assets and obligations for the liabilities relating to the arrangement are parties to a joint operation. A joint operator accounts for assets, liabilities and corresponding revenues and expenses arising from the arrangement. Parties that have rights to the net assets of the arrangement are parties to a joint venture. A joint venturer accounts for an investment in the arrangement using the equity method. MW © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Not structured through a separate vehicle * Classification 6 Not structured through a separate vehicle * Structured through a separate vehicle * Assessment of the parties’ rights and obligations Assess the parties’ rights and obligations arising from the arrangement by considering: the legal form of the separate vehicle the terms of the contractual arrangement, and, if relevant, other facts and circumstances Parties have rights to the assets and obligations for the liabilities Parties have rights to the net assets Joint operation Joint venture Accounting reflects the parties’ rights and obligations Accounting for assets, liabilities, revenues and expenses in accordance with the contractual arrangements Accounting for an investment using the equity method (*): A separate vehicle is a separately identifiable financial structure, including separate legal entities or entities recognised by statute, regardless of whether those entities have a legal personality.

Separate vehicles Legal form 7 Legal form Do the parties have rights to the assets and obligations for the liabilities? Joint Operation Yes No Contractual terms Do the parties have contractual rights to the assets, and obligations for the liabilities? Yes No Other Is the arrangement designed so: Its activities primarily aim to provide parties with an output, and (b) It depends on the parties for settling liabilities? Yes No Joint Venture © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Example: Construction and real estate 8 A separate vehicle is established, over which two parties have joint control. The purpose of the Joint Arrangement is to construct and sell residential units to the public Neither the legal form nor the contractual terms give the parties rights to the assets or obligations for the liabilities of the arrangement Contributed equity by the parties is sufficient to buy the land and raise debt finance for the construction Sales proceeds will be used to repay external debt and remaining profit is distributed to parties Parties provide guarantee to financier © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Example: Mining 9 A and B jointly establish a corporation D over which they have joint control to process the ore from the mine C A & B have agreed to the following: A & B will purchase all the output produced by D in a ratio of 60:40 (in proportion to ownership interest in D) D cannot sell the output to third parties Price of the output is set by A and B at a level to cover production and admin costs (i.e. D breaks even) © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Comparison to the IFRS for SMEs 10 Some of the differences between Section 15 Investments in Joint Ventures of the IFRS for SMEs and IFRS 11 include: Section 15 has different methods of accounting for jointly controlled entities to full IFRSs. The IFRS for SMEs permits use of the equity method, cost or the fair value model. If the equity method is used, any implicit goodwill is systematically amortised over its expected useful life— full IFRS does not allow amortisation of goodwill. MW © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Evaluating the differences 11 The rules in Section 15 require fewer judgements The principle-based approach in IFRS 11 enhances verifiability and understandability the accounting in IFRS 11 reflects more faithfully the economic phenomena that it purports to represent improves consistency it provides the same accounting outcome for each type of joint arrangement increases comparability among financial statements it will enable users to identify and understand similarities in, and differences between, different arrangements © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Judgements and estimates 12 Assessing whether the parties, or a group of parties, have joint control of an arrangement (see IFRS 10 for judgements about control). Determining whether the joint arrangement is a joint operation or a joint venture requires consideration of the structure and legal form of the arrangement, the terms agreed and when relevant other facts and circumstances. MW © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

IFRS 12 Disclosure of Interests in Other Entities MW © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Objective 14 The IFRS requires an entity to disclose information that enables users of financial statements to evaluate: the nature of, and risks associated with, its interests in other entities; and the effects of those interests on its financial position, financial performance and cash flows. That evaluation assists users in making decisions about providing resources to the entity. MW © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Requirements Disclosures significant judgements and assumptions made 15 Disclosures significant judgements and assumptions made information about interests in: subsidiaries joint arrangements and associates unconsolidated structured entities any additional information that is necessary to meet the disclosure objective Explain that the disclosure about significant judgements and assumptions made refers to those made by the reporting entity when assessing whether its involvement is such that it controls (or does not control) an entity. In addition, if it does not control an entity, how it assessed that whether it jointly controlled or had significant influence over that other entity. In effect, this disclosure is saying ‘when the determination of control/joint control/significant influence was difficult, explain how to came to your conclusion.’ Re aggregation and ‘striking the right balance’, we will include some guidance on how to aggregate (similar to US GAAP guidance re VIE disclosures). The idea is that the standard will say ‘if its important, tell us about it, and if its not important, we don’t need or want to know’. Strike a balance between overburdening financial statements with excessive detail and obscuring information as a result of too much aggregation © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Joint arrangements and associates 16 Nature, extent and financial effects of interests in joint arrangements and associates, eg* List and nature of interests Quantitative financial information Unrecognised share of losses of JVs and associates Fair value (if published quoted prices available) Nature and extent of any significant restrictions on transferring funds Nature of, and changes in, the risks associated with the involvement Commitments and contingent liabilities * for individually-material joint ventures and associates Main change from IAS 28 and IAS 31: the detailed quantitative summarised financial information for individually material JVs and associates, which aims to help users analyse the reporting entity’s activities that are conducted through JVs and associates, and to value the reporting entity’s investment in those entities (eg they will have a rough idea about the net dent position and will have information to be able to calculate EBITDA).

Judgements and estimates 17 An entity must disclose information about significant judgements and assumptions it has made in determining… joint control (see IFRS 11) of an arrangement or significant influence (see IAS 28) over an entity type of joint arrangement when the arrangement has been structured through a separate vehicle MW © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

IAS 28 Investments in Associates and Joint Ventures MW © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Scope and introduction IAS 28 must be applied by all entities that are investors with joint control of, or significant influence in an investee. An associate is any entity over which the investor has significant influence. A joint venture is joint arrangement whereby the parties have joint control of the arrangement. the contractually agreed sharing of control of an arrangement MW © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Significant influence Significant influence is the power to participate in the financial and operating policy decisions of the investee. significant influence is not control (which indicates a subsidiary) significant influence is not joint control (which indicates an interest in a joint arrangement) MW © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Significant influence continued Significant influence is usually evidenced in one or more of the following ways: representation on the board of directors; participation in policy making, including decisions about dividends; a close relationship involving transactions between investor and investee; interchange of managerial personnel; or provision of essential technical information. MW © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Measurement Measurement rule Associates and joint ventures are accounted for using the equity method. Exemptions from the equity method Entity is a parent and the scope exemption in paragraph 4(a) of IFRS 10 A venture capital organisation or similar entity can elect to measure its investments in associates or joint ventures at fair value through profit or loss in accordance with IFRS 9. MW © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Equity method Recognise the investment initially at cost, then adjusting for the post-acquisition change in the investor’s share of net assets of the associate or joint venture. Presentation: a one-line entry in the statement of comprehensive income ‘investor’s share of the associate or joint venture’s profit or loss’ and a separate line item for other comprehensive income. a one-line item in the statement of financial position— Investment in associate or joint venture. MW © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Example equity method 24 On 1/3/20X1 A buys 30% of B for 300,000 (assume no implicit goodwill & fair value adjustments). B’s profit = 80,000 for the year ended 31/12/20X1 (including 66,667 from March to Dec). On 31/12/20X1 B declared a dividend of 100,000. At 31/12/20X1 the recoverable amount of A’s investment in B = 290,000 (ie fair value 293,000 less costs to sell 3,000). No published price quotation for B. © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Equity method continued Equity accounting for an associate’s losses continues until the investment is reduced to zero. Additional losses may be recognised as a liability if an entity has a legal or constructive obligation or made payments on behalf of the associate or joint venture Recognition of future share of profits only after share of profits equals losses MW © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Equity method continued The ‘investment’ includes not only shares in the associate, but also some non-equity interests such as some long-term receivables. Uniform accounting policies should be used If the associate or joint venture’s year end differs from the investor’s adjustments must be made for significant transactions that occurred between the dates Difference in year-ends may not exceed three months MW © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Equity method continued Goodwill forms part of the investment in associate or joint venture Therefore, the goodwill is tested for impairment as part of a single asset—the investment Application of the equity method is discontinued when: The investment becomes a subsidiary Significant influence or joint control of the investment is lost IFRS 9 application to interest retained (if any) Profit or loss on disposal MW © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Comparison to the IFRS for SMEs The main differences between IAS 28 and Section 14 Investments in Associates and Section 15 Investments in Joint Ventures is in an investor’s primary financial statements are: full IFRSs require investments in associates and joint ventures to be accounted for using the equity method the IFRS for SMEs requires an entity to elect one of three models to account for its investment in associates and joint ventures—the equity method, the cost model and the fair value model. A different model can be used for associates as compared to joint ventures MW © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Comparison to the IFRS for SMEs continued If an SME elects the equity method, the IFRS for SMEs requires that implicit goodwill be systematically amortised throughout its expected useful life (see paragraph 14.8(c))—full IFRS does not allow amortisation of goodwill MW © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Judgements and estimates Investors must exercise judgement in the context of all available information to determine whether they have significant influence over an investee. There is no exemption from equity accounting when severe long-term restrictions impair the associate’s ability to transfer funds to the investor. However, the investor should consider whether such restrictions, taken with other factors, indicate that the investor does not have significant influence MW © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Associate Accounting

Example Suppose Big Corp has a investment in ABC Corp of 30% It has no Control and we would need to ensure Significant Influence. So long as it does then... It is an associate and we incorporate the parents share of post acquisition profits on the Equity Basis. We show the initial purchase price paid as a Non Current Asset. We add to this our share of post acquisition profits. We deduct from this any dividends received. 32

The Parent-Subsidiary Relationship Big Corp Small Corp 30% ownership Equity Basis of Consolidation 33

Example Suppose Big Corp has a investment in ABC Corp of 19% It clearly has no Control and we would need to ensure no Significant Influence. If there is no Significant Influence then the investment is treated under the Cost basis. It is an associate or an investment not a subsidiary. 34

Simple Investment Accounting Where we have no control or significant influence, normally less than 20%. We use Cost Method. We show the Purchase as a Non Current Asset. Dividends are shown as income in the Income Statement

The Cost Method - How It Works Parent Record the investment at “cost.” General Rule: Leave it on the books at cost. Can revalue to fair value. Income to parent is just dividends Investment 36

The Parent- Associate Relationship Big Corp Can NOT Exercise Significant Influence ABC Corp Owns less than 20% Cost Basis of Consolidation 37