Liabilities in relation to a joint operator's interest in a joint operation (Agenda Paper 9)

Background

In its September 2018 meeting the Committee discussed the recognition of lease liabilities by a party to an unincorporated joint operation when applying IFRS 11. The lead operator (as a party to the JOA) enters into a lease with a third-party supplier for an item of property, plant and equipment to be used as part of the relevant activities of the joint operation throughout the term of the lease. The lead operator has a primary responsibility for the liability towards the third-party supplier. Some of the lease contracts contain a recourse clause against other joint operators in the event of non-payment by the lead operator.

IFRS 11:20(b) which requires the recognition of a joint operator’s ‘liabilities, including its share of any liabilities incurred jointly’ applies to the case. The staff analysed the requirement as including both (a) liabilities incurred by a joint operator in relation to its interest in a joint operation; and (b) the joint operator’s share of any liabilities incurred jointly in relation to its interest in the joint operation. The identification of a joint operator’s liabilities and any liabilities incurred jointly depends on the terms and conditions of all the contractual arrangements or agreements relating to the joint operation.

The lead operator shall recognise a right-of-use asset and a lease liability equal to the full amount of lease payment that the lead operator is obligated to pay to the lessor. In the case of a lease contract that contains a recourse clause against other joint operators in the event of non-payment by the lead operator (through guarantee or indemnity), the staff analyse that each joint operator (who is legally bound by the JOA) has the primary responsibility for its proportionate share of the lease liability towards the lead operator, but only a secondary responsibility towards the lessor in the case of default by the lead operator. If the lease contract had been signed between the joint operation and the lessor, the joint operation would have the primary responsibility for the liability towards the lessor and therefore the lease liability would appear to be a liability incurred jointly by the joint operators. Accordingly, each joint operator would recognise its proportionate share of the overall lease liability (and the corresponding right-of-use asset). The staff further analysed that for the case submitted, the JOA, in effect, creates a sublease between the lead operator and the joint operation and therefore the lead operator shall recognise a net investment in a sublease which represents the right to recover a share of the lease costs.

There were different views from the Committee members during the September 2018 meeting. Some Committee members were concerned about whether the lead operator has a legal obligation for the entire lease liability or only for the portion it is attributed, while the staff considered the primary obligation is on the lead operator who signed the lease agreement while the rights and obligations as stated in the JOA are those between the parties to the joint operation. Some other Committee members had an issue with the sublease, however that was not discussed in the meeting. Despite the concerns, nine members of the Committee voted in favour of the tentative agenda decision which includes the above staff analysis.

Comment letters were received and a number of respondents stated disagreement with the technical analysis and the conclusions. Those concerns are illustrated below.

Staff analysis

Respondents raised concerns on the assessment of whether the lead operator has signed on behalf of the joint operation because IFRS 16:B11 is clear that the joint operation is the customer of the lease contract. Some respondents say that the staff analysis does not reflect the combined economic substance of all the relevant agreements. The staff analyse that IFRS 11 is clear in terms of the economic substance of the joint arrangement depending on the rights and obligations assumed by the parties when carrying out the joint arrangement's activities. The Standard is also clear that the accounting treatment reflects the contractual rights and obligations having considered all relevant contractual arrangements and applicable laws. The lead operator's primary responsibility for the lease liability arising from the lease contract has not been extinguished or transferred. Accordingly, the staff continues to agree with the Committee's conclusion that the rights and obligations between the lease contract (entered into between the lessor and lead operator who has the primary responsibility to meet the lease liability) and the JOA (entered into between a lead operator and other operator(s), so that the lead operator has a right to recover the costs from the other joint operator(s)) shall be accounted for separately. The staff has also mentioned the case will be different if each joint operator has primary responsibility for only its pro-rata share of lease liability. A detailed assessment and understanding of each arrangement is required when determining the appropriate accounting.

A number of respondents suggested addressing the debit side of the entry (i.e. the right-of-use asset) but the staff analyse that the tentative agenda decision is narrowly scoped and only addresses the question asked about identification of liabilities of a joint operator and it is not necessary to address the rights arising from the contractual agreements.

On the other hand, certain respondents commented that the agenda decision would affect their IFRS 16 implementation in terms of timing, and recommended addressing this matter through the IFRS 11 post-implementation review (PIR) or an Interpretation or amendment. As decided in the September 2018 meeting, this matter is not added to the standard-setting agenda because the Committee concluded that the requirements in IFRS Standards provide an adequate basis for an entity to determine the appropriate accounting treatment. The staff noted that the Board decided to investigate this matter as part of the IFRS 11 PIR.

Staff recommendation

The staff recommend (i) finalising the agenda decision subject to changing the term 'lead operator' in the staff paper to 'the operator'; (ii) including in IFRIC Update that the entity is entitled to sufficient time in determining the change in accounting policy as a result of the agenda decision, in order to address respondents' concerns on the timing of IFRS 16 implementation and (iii) reporting the recommendations from respondents regarding the IFRS 11 PIR to the Board.

Discussion

Except for one Committee member, who struggled with the technical analysis of IFRS 16 and IFRS 11 and disagreed with the Agenda Decision, all Committee members were supportive of the staff analysis. They said they understand the staff's assessment of "economic substance" and "primary responsibility" which is identified by the rights and obligations defined in the contractual arrangements. The economic substance is different for the situations of (i) an entity entering into a lease then receiving reimbursement from a joint operator and (ii) two entities jointly entering into a lease. Some Committee members were supportive of finalising the Agenda Decision because they foresee many similar accounting questions relating to joint operations.

A Committee member expressed that it does not make sense to see a different accounting outcome for the same transaction only because it is carried out by different kinds of joint arrangements (joint operation vs. joint venture).

The Chair concluded that the Committee should report on the recognition of subleases and the different accounting outcomes depending on the structure of the joint arrangement to the Board as part of the IFRS 11 PIR.

The Committee decided, by a majority of votes, to publish the Agenda Decision with no changes.