Focus on the nature of the joint arrangements rights and obligations
A joint arrangement can either be a joint operation or a joint venture under IFRS 11. In determining the classification of joint arrangements, the existence of a separate vehicle is a necessary condition, but not sufficient for a joint arrangement to be considered a joint venture. IFRS 11 clarifies that other factors like terms of the contractual arrangement and relevant facts and circumstances are to be considered as well.
Jointly-controlled entities, as previously defined in IAS 31 1, may be classified as joint ventures and hence accounted for using the equity method in IFRS 11. The choice of using proportionate consolidation has been removed under IFRS 11. The impact of changing from proportionate consolidation to the equity method could be significant where such investments in jointly-controlled entities are material to the financial statements. This has in turn impacted computations of key performance indicators used to assess the performance of an entity, including that used for the loan covenant compliance, analyst and shareholders’ communications, and share-based payment vesting conditions.
Power over relevant activities
An investor has power over an investee when the investor has existing rights that give it the current ability to direct the relevant activities of the investee (IFRS 10 10). Can an investor have power currently if its decision-making rights relate to an activity that will only occur at a future date?
X and Y set up a new company to construct and operate a toll road. X is responsible for the construction of the toll road, which is expected to take two years. Thereafter, Y has authority on all matters related to toll road operation. Is it possible for Y to have power over the company during the construction phase although X is responsible for construction and has authority to make decisions that need to be made currently?
Y may have power currently even though it cannot yet exercise its decision-making rights. The investor that has the ability to direct the activities that most significantly affect the returns of the investee has power over the investee (IFRS10 B13). The criteria in IFRS 10 B13 example 1 should be applied, which include consideration of:
- the purpose and design of the investee;
- the factors that determine profit margin, revenue and value of the investee. For example, the construction of the road may be under the supervision of the national roads authority. X is contracted to build the road under government supervision and, subject to audit, will recover its costs plus a specified percentage of margin. That margin will be returned through adjustment of the amount of tolls that will flow to X, so that X has first call on the cash flows generated by tolls. Y will manage the toll road operations, including maintenance, and will have be able to claim a management fee equivalent to any residual cash in the entity after all operating expenses have been paid, including payments to X. Y has the ability to set tolls. Alternatively, the arrangement could set out that the government regulates the tolls that can be charged with little variation in expected revenue but gives the investee more discretion over how the toll road is constructed, with X and Y sharing equally in the net cash flows of the investee;
- the effect on the investee’s returns resulting from each investor’s decision-making authority with respect to the factors in b); and
- investors’ exposure to variability of returns.
Re-assessment of power
Two years have passed and the toll road has been fully constructed; and Y has entered bankruptcy, and X has assumed management of the toll road operations and is in discussions with the national roads authority to continue managing those operations.
Should X reassess whether it has control of the investee in this situation?
Yes, X should make this reassessment because there has been a change that affects the power criterion (IFRS 10 B80).
Joint arrangements rights and obligations Joint arrangements rights and obligations Joint arrangements rights and obligations