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IFRS 11 — Joint operations

Date recorded:

Background

The Committee received a submission about the recognition of lease liabilities by a party to an unincorporated joint operation when applying IFRS 11 Joint Arrangements. In the fact pattern set out in the submission, a number of parties establish a joint arrangement by entering into a joint operation agreement (JOA) and the JOA sets out the terms upon which the joint operators participate in the activity that is the subject of the arrangement and outlines the relevant activities of the joint operation, work programme, budgets, capital contributions, etc. The JOA also specifies the joint operator that manages day-to-day activities of the joint operation (lead operator). The lead operator 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 primary responsibility for the liability towards the third-party supplier. Some of the lease contracts contain recourse clause against other joint operators in the event of non-payment by the lead operator.

Staff analysis

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 analyse 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 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 overall lease liability (and the corresponding right-of-use asset). The staff further analyse 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 sublease which represents the right to recover share of lease costs. Staff recommendation

The staff do not recommend to add this matter to its standard-setting agenda since the staff think the existing IFRS Standards provide an adequate basis for such accounting treatment. Instead, the staff recommend that the Committee publish a tentative agenda decision that outlines how a joint operator applies the requirements in IFRS Standards in identifying liabilities in relation to its interests in a joint operation. On the other hand, the Board has already identified this matter as one for its consideration when it undertakes the post-implementation review of IFRS 11.

Discussion

The Chair opened by saying that although the paper covers other aspects of the arrangement, the question the Committee is being asked relates to the liability, and the discussion should focus on that issue.

One member opened by saying he would reach a different conclusion to that reached the staff. When you step back and look at the arrangement the lead operator would be working together with the other operators on the details of the lease and effectively entering into the lease on behalf of the joint operation, which is very close to the wording in IFRS 16.B11. The joint operation is the customer. He said that if the lead operator had purchased an asset with a loan that the staff analysis would suggest that the lead operator would show the full loan and the asset whereas the other operators would only show a lease obligation and a leased asset, which is very different from what people would expect to see in a joint operation situation.  He was also troubled with the sublease analysis because the other operators do not have control over the asset, which is jointly controlled through the joint arrangement.

The Chair asked the member how his view reconciles with accounting for liabilities that is based on legal obligations. He replied that the legal obligation of the lease is effectively shared by the joint operators under the joint arrangement, when one of the operators signed on behalf of the joint operation.

Three other members agreed with this view. One member stated that the lead operator would never have entered into the contract without the agreement of the other operators. Because there is no legal entity, one of the operators has to sign the contract, and the lead operator is signing on behalf of the joint operation. Signing the contract is more of a formality. It is the combination of the joint arrangement contract and the lease contract that should lead to each operators accounting for its share. He said that he understood the analysis and conclusion in the paper, but thought the outcome was odd.

Two members said it is a matter of whether you focus on the legal obligations or the substance of arrangement. They could see both views, but they thought that IFRS 11 allowed you to get to the substance answer. One member said that because it is not clear it would not be appropriate to issue an Agenda Decision saying that it is clear.

The Chair said they need to be careful saying that the lead operator only signed the contract because of the other arrangement. Signing the lease contract creates a real legal obligation. Although the cash flows from all of the operators will, in the normal course of events, be used to pay the lease it is important to focus on the legal responsibilities because IFRS liability accounting is based on legal obligations.

The staff stated that even though other operators have contractually committed to pay their share of the liability, the analysis is focused on the fact that by law and the terms of the contract, the joint operating agreement does not take away the fact that the lead operator has responsibility for 100% of the liability to the lessor (i.e. the lead operator has primary responsibility of the legal obligations). The staff absolutely agree that the joint operating agreement will create rights and responsibilities, but these are rights and obligations between the parties to the joint operation. They do not take away the primary obligation of the lead operator.

Most of the other Committee members who spoke agreed with the staff analysis.

One member said it was similar to an issue the Committee had discussed in 2016 relating to a service concession in which the operator had signed a lease on behalf of a grantor.  One member said that this was similar to an issue discussed in 2016 on a service concession where an operator leased on behalf of a grantor. The committee decided that you cannot look through the arrangement. The operator has the legal operation and the agreement with grantor does not extinguish the liability. One member noted that when the Committee issued a large batch of Agenda Decisions about IFRS 11 it was clear that when you are dealing with an incorporated entity versus an unincorporated joint operation you do get different accounting outcomes, because the rights and obligations are different. Another member said that once you have the obligation it is very difficult to derecognise it. Another Committee member also pointed out that the joint operating agreement has created another separate legal obligation between the lead operator and other joint operators giving the lead operator the right to recover part of the liability paid from the other joint operators. The member thought that the analysis of a two-step approach is appropriate.

Several members said they had questions or concerns about the sub-lease parts of the paper. These were not discussed in the meeting.  

In respect of the suggestions to the wording of a tentative Agenda Decision, a few Committee members consider the Agenda Decision should focus primarily on the lead operator's liability. Some Committee members also suggested some amendments including the term "joint operator" in the last paragraph of the tentative Agenda Decision should be "lead operator". It should also be clear that the lead operator "recognises" a liability but not "incurs" a liability. The staff also proposed changing "[t]he Committee observed that the liabilities that a joint operator incurs include those for which it has primary responsibility, including for example liabilities for which it has a present obligation to make payments" to "[t]he Committee observed that the liabilities that a joint operator recognises include those for which it has primary responsibility."

Decision

Nine members of the Committee voted in favour of issuing a tentative Agenda Decision, subject to the changes mentioned above.

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