Arthur et al. Q8.7 Comparison of joint ventures and joint operations
Why joint ventures?
An entity may enter a joint venture with another party as opposed to undertaking the transaction in its own right for the following reasons.
The scale of the required investment may be beyond the entity’s financial means.
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Special skills may be required to manage and operate the project.
Risk can be shared, particularly if the project involves substantial commercial risk.
A foreign government may require that a foreign entity or the foreign government
itself be a partner to a business venture located in its jurisdiction.
Accounting treatment of joint arrangements
Joint arrangement
Joint operation
Joint venture
Accounting treatment
Venturer to recognise its interest in each asset employed, each liability arising, expenses arising and revenues from the sale of its share of the output of the joint operation (otherwise known as the line-by- line method).
Venturer to use the equity method of accounting.
See Section 8.4
See Chapter 9
Each method is compared to the full consolidation method in the following table.
Full consolidation Equity method Line-by-line
Where applied?
Outside the primary records using consolidation worksheet
As part of the consolidation or in the primary records if there is no consolidation
In the primary records of the venturer
The technique
Line-by-line aggregation of 100% of the financial statement items subject to eliminations and adjustments
Proportional consolidation of the post-acquisition profits and movements in reserves using one- line asset account
Line-by-line aggregation of the venturer’s proportionate interest in each asset, liability and production cost
Recognised on consolidation and subject to impairment testing
Embedded in the investment asset and entire value of investment subject to impairment testing
Usually no goodwill
Fair value issues
Recognition of the fair values of identifiable net assets and contingent liabilities at the date of acquisition and related depreciation if not already ‘booked’ by the subsidiary
Fair value adjustments for depreciation of non- current assets if not already booked by the subsidiary
Revaluation of remaining interest in non-current assets contributed if the fair value basis of measurement applies
Other adjustments
Full elimination of the financial effects of inter-entity transactions and balances including:
– investment asset – sales/purchases
– unrealised profits – dividend revenues
– other revenues/ expenses
Proportional elimination of unrealised profits and losses included in inventory or non- current assets
Depreciation and amortisation of non- current assets employed in joint venture operations and allocation to inventory
Preference for a joint operation
The main advantage of a joint operation is the degree of flexibility that this form of arrangement has relative to other organisational forms including incorporation. An entity and its directors must comply with all relevant requirements of the Corporations Act 2001 but a joint operation is a ‘slave’ only to the specific terms and conditions of the contracts that comprise the joint venture agreement. Because of flexibility, it is potentially easier to organise a relationship with another joint operator in a joint operation than with another shareholder in a joint venture.
Preference for a joint venture
A joint venture in the form of a company offers the protection of ‘limited liability’. In some industries and for some commercial arrangements, a joint operation is just not an effective commercial arrangement. This is so particularly if brand development or sales and marketing activities are an integral part of the businesses’ activities. By definition, a joint operation does not ‘drive’ marketing and selling; rather, this is the responsibility of the separate venturers. Accordingly, selling and marketing activities are fragmented when a joint operation is used. This sort of fragmentation makes no difference if the product is homogenous and markets are close to perfect (e.g., sale of gold) but is likely to be economically suboptimal in other cases.
A joint venture may sometimes be preferred by management because of the relative appeal of the equity method of accounting. The equity method has the same statement of comprehensive income effects as a proportional consolidation without requiring any additional liabilities to be recognised in the statement of financial position.
Arthur et al. Q8.8 Features of a joint operation (Sections 8.3.7 and 8.3.8)
Several features of a joint operation could be discussed but for the purposes of this question the following have been selected.
Flexibility
As joint operations are versatile arrangements not subject to statutory requirements, the AASB 11.7 joint venture and joint control definitions’ ‘contractual’ criteria specifically accommodate the need to document essential information about joint operations in its joint venture agreement so all stakeholders can make informed decisions. For example, auditors can review the joint venture agreement and determine if joint control will be achieved between the joint operators, the structure of the joint venture arrangement and whether the joint operator has adopted the correct accounting treatment in its financial statements.
Another example of the flexibility feature occurs when joint operators own joint operation assets as tenants in common and have an undivided interest in each separate joint operation asset. On the basis that an asset contribution does not provide evidence of an impairment loss and significant risks and benefits of ownership have been transferred to the other joint operators, asset-contributing joint operators will only recognise the portion of the gain or loss that is attributable to the other venturers’ interests (AASB 11.B34 Liability).
Unless there are special arrangements, such as guarantees or cross-charges, each joint operator is separately liable for their own obligations and jointly liable for obligations incurred by the joint operation manager on behalf of the joint operators. AASB 11 accommodates this unique feature by permitting joint operators to use the line-by-line method and recognise in their financial statements their interest in each joint operation’s liabilities.
Different opinions will be presented as to whether the accounting requirements mentioned will result in more useful financial information. Considering the joint venture agreement is necessary so joint operators’ financial statements can reflect the substance of contribution transactions and their specific exposure to joint operations liabilities, it is a useful solution so financial statement users can make more informed decisions about joint operator’s investments, gain on sale of assets to joint operations and debt exposures to joint operations.
Arthur et al. Q8.9 Line-by-line method and its conceptual issues (Section 8.5.2)
The line-by-line method requires a joint operator to recognise its interest in each asset, liability, revenue and expense item of a joint operation. The proportion amounts are then aggregated with similar line items in the joint operators’ financial statements (AASB 11. 20). The line-by-line method recognises by an adjusting journal entry the part of a joint operation’s assets, liabilities, revenue and expenses which is controlled by a joint operator in its own financial statements as though the joint operator had directly incurred or derived these transactions. Accordingly, the joint operator’s financial statements mix directly controlled items with disaggregated amounts from a joint operation which the joint operator does not unilaterally control.
The AASB Framework for the Preparation and Presentation of Financial Statements (paragraph 49(a)) requires a resource to be controlled before it can be recognised as an asset. In view of this, it is doubtful whether an undivided interest in an asset recognised under the line-by-line method meets the control test for asset recognition imposed by the AASB Framework. An interest in an asset under the line-by-line method represents a right to enjoy part of the benefits of the asset rather than control all the benefits of the asset. It can be argued that the recognition of assets by the line-by-line basis distorts the statement of financial position because fully controlled assets are aggregated with joint operation assets. For example, at year end, a joint operator recognises an interest in a joint operation’s cash and cash equivalents in its financial statements. This adjustment to the joint operator’s financial statements will improve its liquidity position even if it is questionable whether the joint operator could use its interest in the ‘Cash and cash equivalents’ for any of its own purposes. The use of the line-by-line method without supplementary disclosure completely hides the existence of an interest in a joint operation as all financial aspects of the joint operation are absorbed into the financial statements of the joint operator.
This problem is addressed by the disclosure requirements of AASB 12 for joint ventures by requiring disclosure of the aggregate amounts of each of the current assets, long- term assets, current liabilities, long-term liabilities, income and expenses recognised.
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