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IFRS 11 – Analysis of implementation issues

Date recorded:

The Committee has received several requests with respect to the application of the requirements of IFRS 11 Joint Arrangements. One of the issues identified as a priority issue for further consideration was whether an assessment of ‘other facts and circumstances’ should take into account facts and circumstances that do not involve contractual and (legal) enforceable terms. This issue was discussed at the Committee’s January 2014 meeting and the papers discussed at this meeting were in response to those discussions.

Paper 5A contains an analysis of how and why ‘other facts and circumstances’ create rights and obligations that result in a joint arrangement being classified as a joint operation, including fact patterns illustrating some of the sub-issues identified.

Paper 5B considers the application of the requirements of IFRS 11 to some common joint arrangement structures.

The Chairman noted at the outset that the Committee needed to do some serious thinking about where they were going with this, noting that this was the third time they had discussed issues relating to IFRS 11, adding that the Committee needed to think hard about what the output of this was likely to be, and whether it would be worth the effort.

A Committee member noted that he liked the structure of the paper as it highlighted the fact that in IFRS 11, in many cases, management judgement is absolutely necessary.

Another Committee member noted that the question was focused on ‘what is the other facts and circumstances test’ and that the analysis pointed to the test assessing ‘do we have a contractual commitment to take substantially all the output at a price that is expected to meet the obligations of the entity in the normal course of business’. He observed that in this situation, the pricing would not matter (except in relation to the adequacy of cash flows), the output would not matter, and third party financing would not matter. He noted that if that was what was intended, then the issue was easily solvable and could be clarified through an agenda decision or amendment to IFRS 11 to state what the other facts and circumstances test was. However, he noted that if the Board meant other facts and circumstances more broadly, then things like the price at which the output was sold would be relevant, not just in relation to the adequacy of the cash flows, but because it would affect the transfer of risk between the parties and the investee. He noted that it was unclear whether the Committee was dealing with a narrow exemption to the basic classification principles in IFRS 11, or with assessing who has the risks and economic benefits associated with the activities of the investee.

Another Committee member expressed concern regarding where this issue was going and noted that there could be unintended consequences for those entities that had already adopted IFRS 11. He noted that he did not disagree with the paper, but wondered if there was a danger that the Committee could end up effectively setting GAAP or embedding an interpretation in some examples because the message had not come through clearly enough from the standard. He also noted that he was uncertain whether a clear principle could be pulled from the analysis and examples in the paper. He emphasised the importance of getting back to the question of ‘what did the Board mean when it wrote IFRS 11’. He expressed concern about the risk of ending up with numerous examples coming to the Committee on this and noted that there was a need for the Committee to get back to the principle intended by the Board. He noted that the Senior Director, Technical Activities had said in the previous meeting that the Board expected joint operations within legal entities to be a fairly narrow subset, and suggested that rather than the Committee trying to interpret or draft examples, it would be better to ask the Board what they meant by other facts and circumstances. Did the Board mean something very narrow, which would only apply when the parties were obligated to take all the output so that they had ongoing obligations for the liabilities, or did they mean something wider and that such items as the purpose, design, and intent of the parties should be considered?

Another Committee member agreed with the comments made by the previous Committee member. He noted that overall the construct and analysis in the paper made sense; however, he expressed concerns that it was difficult to determine whether some of the implicit assumptions in the paper were critical to the conclusion or not. He gave the example of paragraph 39(d), where one of the assumptions was ‘the contractual arrangement between the parties to use substantially all of the capacity of the plant, which is aligned to the useful lives of the equipment’ and noted that it was unclear whether it was critical to the conclusion that the capacity and the contractual arrangement were aligned with the useful life,.He reiterated the concerns expressed by the previous Committee member with respect to the Committee risking to deal with a number of variations of examples over time, and agreed that the best approach would be to take this back to the Board and seek clarification as to what was meant and what the principle was behind other facts and circumstances.

Another Committee member noted that he shared the concerns expressed above, adding that examples could be useful when management was required to apply judgement; however, he also cautioned that they had the potential to raise more questions when users were trying to apply them to their specific cases, and noted that the best way forward would be for the Committee to go back to the Board to clarify the principles for application.

One of the Board members present commented that it was unfortunate that the standard gave only one example of other facts and circumstances, and that this example was not introduced as being one example among many others, but instead it could be read as being the only case where the Board considered the legal form could be overridden; to which he noted that, personally, he believed this was too narrow. He noted that he supported the Committee asking the Board to examine the issue, to decide whether to add to the example or to restrict and state clearly that the example currently in the standard was the only case where the legal form can be overridden. He noted that he did not recall the Board having discussed other situations. He noted that the Committee should look at some examples before going to the Board, adding that the work of the Committee would help the Board decide what they should do.

Another Committee member noted that he was making the (perhaps inappropriate) assumption that the principles in the analysis were what the Board meant, but expressed concern with respect to how these would be communicated through examples. He noted that there are a number of industries with different structures, adding that at some point, there would be too many examples to make any sense. He noted that the information in the examples might be better as educational material rather than being added to the standard, and suggested to avoid examples if possible, because examples can raise additional questions.

Another Board member noted that she agreed with the comments made by the first Board member. She cautioned the Committee members that, before assuming that the points in the paper were the principles the Board had in mind when they wrote IFRS 11 and spending time coming up with examples that meet those principles, the Committee should check with the Board that these were indeed the principles they had in mind.

Another Committee member agreed that constituents have always asked whether the example in the standard is the only example whereby a party could classify a joint venture as a joint operation. She noted that based on her reading of the paper and the standard, there could be a situation whereby instead of purchasing output the partners were leasing – but other than these two cases, she was not sure that there would be other cases where this would work. She noted therefore that what seemed to be key was that as long as you received cash from third parties, you could never demonstrate a joint operation. With respect to paragraph 12 in staff paper 5B, which concludes that Features AD (thin capitalisation, no workforce, type of assets and liabilities and a limited-life entity) would not create ‘inferred’ rights, she noted that she felt that the staff had dismissed these features too quickly saying they did not affect the parties’ rights to economic benefits of the assets and obligations to acquire those economic benefits. She noted that those features demonstrated that an entity had no legal autonomy, which was the centre of the debate. She also noted that she recognised that some countries had already adopted IFRS 11, but noted there were a number that would be adopting in 2014 (most of Europe), and because there was uncertainty out there with respect to how IFRS 11 could be applied, anything that could be done to provide clearer guidance in the near future would be helpful.

Another Committee member noted that for the Committee to go back to the Board on the meaning of ‘other facts and circumstances’ did not make much sense because of the choice of words used. He questioned why, if the Board had intended a narrow interpretation, they would have used the term ‘other facts and circumstances’. He noted that, to him, using ‘other facts and circumstances’ means substance over form. He noted that the paper talked about inferred rights and inferred obligations, and questioned what inferred rights vs. rights were if it was not substance over form. He cautioned the Committee on trying to work through all sorts of examples and fact patterns, noting that it may be okay to illustrate what an inferred right might be but that the Committee should refrain from going elsewhere; specifically, they should refrain from going into the issue of which facts and circumstances gave inferred rights, noting that they should basically just go with the substance, and it is not a matter of judgement. He summed up by saying that if it was not clear that ‘other facts and circumstances’ meant substance over form, then the Committee should go to Board for clarification; however, he noted that personally he thought it was obvious that this was a case of substance over form and it was just a question of the facts. He emphasised that other facts and circumstances needed to create rights and obligations and in substance parties may have these rights and obligations even though legally they did not have these rights and obligations.

In response to the comments made by the previous Committee member, the third Board member present noted that he preferred this approach to the approach whereby the Committee would go back to the Board to clarify what the Board meant when they developed IFRS 11, adding that Board members change, and that the words in the IFRS are very important. He further noted that if the Committee members believed the current standard is not right, and they thought the Board members needed to correct the standard, they should give direct advice to the Board to improve the standard, and he invited such suggestions from the Committee.

Another of the Board members present also noted that he agreed with the comments made by the previous Committee member. He noted that he was concerned with the link between paragraphs B30 and B31 of IFRS 11, and noted that the Board would be very happy to receive suggestions from the Committee on how to proceed to clarify the requirements.

Another Committee member also agreed with the previous Committee member’s analysis, noting that the current examples add confusion. She noted that clarification with respect to the distinction between gross and net rights and obligations would be helpful.

Another Committee member noted that, in a previous meeting, the Committee had established that other facts and circumstances needed to give rise to rights and obligations, and the Committee had asked the staff to go away and perform analysis on how other facts and circumstances created those rights and obligations. He noted that the conclusion in paragraphs 37 and 38 of the staff paper with respect to when parties to a joint arrangement have inferred rights to assets and inferred obligations for liabilities was useful, and that incorporating this as part of how to assess rights and obligations arising from other facts and circumstances would be beneficial. He noted that he was confused regarding the substance over form discussion, noting that a party either had rights or obligations or it did not. He noted that he did not like the term ‘inferred’ and cautioned against using the term in any pronouncement. He noted that he agreed with the conclusion reached by the staff in paper 5B, but further noted that the Committee should confirm with the Board that the thinking on how rights and obligations are assessed is correct before asking staff to develop illustrative examples.

The Senior Director, Technical Activities commented, noting that the value added by the current examples was in their ability to help identify problems rather than necessarily solve them. He noted that he believed the Committee could add value in helping to develop examples to provide to the Board that identify the issues that the Committee would like the Board’s guidance on; and taking the 27 issues initially raised on IFRS 11 and determining which ones can be put aside or dismissed.

In summing up, the Chairman highlighted two items he believed had been the focus of the discussion:

  1. Role of Entity — At the last meeting it was mentioned that the Board thought it would be unusual for a joint operation to be housed in an entity, noting that in certain legal jurisdictions, every joint operation was a legal entity (a partnership). Accordingly, ‘entity’ must have meant something that had the effect of limiting liability (i.e. a corporation), and even in a partnership the parties did not have gross rights in all circumstances, as partners’ capital accounts were net rights.
  2. Other facts and circumstances — Did this mean substance over form or was something required that creates rights to assets and obligations for liabilities?

He noted that, consistent with the comments made by the Senior Director, Technical Activities, he recognised that the Committee would need to work through the examples in order to highlight the uncertainties, and proposed going back to the Board with a more concise analysis of what the key uncertainties are.

Another Committee member noted that, in a situation where a party was looking at other facts and circumstances, the party had already determined that the legal form and contractual rights did not, in form, give the party rights to the assets or obligations for the liabilities. If this were the case, the party would not have to look at other facts and circumstances. He noted that other facts and circumstances were analysed to determine whether, in substance. the party had rights and obligations, even though in form it did not. Accordingly, substance over form was not saying that a party did not need rights and obligations; rather, it was saying that even though the form did not give a party rights and obligations, the substance did.

There was discussion amongst the Committee members and staff with respect to the timing going forward, with recognition of the fact that European filers would be applying IFRS 11 in their interim financial statements.

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