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Under Section 3056, an investor is required to account for its interest according to its rights and obligations in the joint arrangement.

Alliances

Posted on May 8, 2015

In September 2014, the Accounting Standards Board issued Section 3056, Interests in Joint Arrangements. It replaces Section 3055, Interests in Joint Ventures, and is based on the principles in IFRS 11, Joint Arrangements. Section 3056 is effective for fiscal years beginning on or after January 1, 2016.

Who will be impacted?

Private companies that have interests in joint ventures (now called “joint arrangements”) and apply the Accounting Standards for Private Enterprises financial reporting framework. The issuance of Section 3056 is expected to affect companies in the real estate, construction and mining industries where joint arrangements are most prevalent.

What has changed?

The main elements of the standard have not changed – including what constitutes “joint control” and the different types of joint arrangements. What has changed is the accounting for these joint arrangements. The key changes are summarized below:

Elimination of accounting policy choice

Under Section 3055, an investor has a policy choice to account for its interests in joint ventures using the cost method, the equity method or the proportionate consolidation method. Under Section 3056, this policy choice has been eliminated and an investor is required to account for its interest according to its rights and obligations in the joint arrangement. As a result, an investor with an interest in a jointly controlled asset or jointly controlled operation has rights to the individual assets and obligations for the individual liabilities of the joint arrangement and will recognize its share of the assets, liabilities, revenues and expenses in that joint arrangement. An investor with an interest in a jointly controlled enterprise (JCE) has an accounting policy choice to either: a) apply the cost method to all JCEs b) apply the equity method to all JCEs or c) perform an analysis of its interest in each JCE to determine whether its interest represents a right to the net assets or a right to the individual assets and obligations for the individual liabilities related to the joint arrangement. An investor that has a right to only the JCE’s net assets would account for such interest using the cost or equity method. An investor with a right to the individual assets and obligations for the liabilities of the JCE would recognize its share of each of the assets, liabilities, revenues and expenses relating to the joint arrangement.

Analysis of a jointly controlled enterprise (JCE)

The analysis of an interest in a jointly controlled enterprise requires the investor to consider whether the legal form or the terms of the contractual arrangement gives the investor rights to the assets and obligations for the liabilities of the JCE. If neither the legal form nor the contractual terms give the investor those rights and obligations, then the investor should consider “other facts and circumstances”. Other facts and circumstances address situations where the JCE is designed to provide the investors with its output such that the liabilities are satisfied by cash flows received from the investors on their purchases. The analysis of other facts and circumstances is expected to be an area of significant judgment.

If the investor no longer qualifies for proportionate consolidation of its JCE

If an investor elects to perform the analysis and determines that its interest in a JCE represents an interest in the net assets only, it would be required to account for such interest using the cost or equity method. This would result in the investor recording a “one line” investment in its balance sheet and a corresponding “one line” share of the earnings (or dividends) from the joint arrangement in its income statement. For investors which conduct a significant portion of their business through joint arrangements and currently apply proportionate consolidation, this could have a significant impact on their financial statements. Investors in this situation would need to consider the implications to their key performance measures, compliance with bank covenants and other contractual arrangements (e.g. earn-outs).

If the investor has rights to the individual assets and obligations for the liabilities of the JCE

If an investor elects to perform the analysis and determines that it has rights to the individual assets and obligations for the liabilities of a JCE, it would be required to account for its share of those assets, liabilities, revenues and expenses. This accounting is similar to proportionate consolidation, but it could produce different results where the investor’s ownership interest in the JCE is different from its rights to individual assets and obligations for individual liabilities as specified in the joint arrangement contract (e.g. the investor may have a 50% equity ownership interest in a JCE but have an obligation for 100% of an environmental liability).

Contributions

Accounting for gains on contribution to a joint arrangement has been simplified – the requirement to “defer and amortize” the portion of the gain that does not relate to the amount of cash or fair value of certain other assets received on the contribution has been removed.

Transition

The standard provides relief from full retrospective restatement when there is a change in the accounting: 1) from proportionate consolidation to the cost or equity method and 2) from the cost or equity method to recognizing an interest in the assets and liabilities of the joint arrangement. Given the latter transition is often the more complicated one, several options are provided for the initial measurement of the investor’s interest in the assets and liabilities of the joint arrangement.

Getting started

A few thoughts on how to prepare for the adoption of Section 3056:

For each interest held in a joint arrangement, determine the type of joint arrangement (i.e. jointly controlled assets, jointly controlled operations, jointly controlled enterprise)
For interests in jointly controlled assets and operations, determine whether a change in accounting is required (i.e. the cost or equity method is no longer permitted). Identify the information necessary to determine the investor’s rights to assets and obligations for liabilities in each arrangement.
For interests in jointly controlled enterprises, determine whether the entity will elect to analyze its interests. If so, gather the necessary information to perform such analysis, including the agreements governing the joint arrangement, details of the legal form, and other facts and circumstances.

Beginning the process early will allow management time to consider the financial reporting implications and the best adoption strategy for them. As always, feel free to contact us if you have questions regarding the application of the new standard.

Diana De Acetis

Diana De Acetis
Partner, National Services

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