IFRS 11: Joint operations and Joint ventures

 

Welcome to IFRS is easy's flash term for the week

Understanding the difference between Joint operations and Joint ventures

Have you ever heard a word in accounting before and you feel you know the literal meaning of it but deep down you wonder what the accounting implication could be? This is me before learning about these two terms.

I used to have them confused especially when I hear other terms used within the same standard such as joint arrangements or joint control. Ah! IFRS can formulate terms ehn.

So what led to these two terms and what is the essence? How is it different from accounting for an investment in a subsidiary, an associate, or an ordinary investment?

Our university undergraduate accounting knowledge simplifies the above as follows:

• Ordinary investment - indicates an investment of less than 20% in an entity
• Investment in associate - indicates an investment of 20% but less than 50%
• Investment in joint venture - indicates an investment of 50%
• Investment in a subsidiary - indicates 50% and above

 We will be focusing on that aspect of joint ownership.

You see, the above hard and fast rule does not work most of the time in practice and we will see why this is so, shortly.

Any time it seems as though two or more investors are coming together to pool funds for a certain activity, there are two major assessments that are to be made.

1. Does a joint arrangement exist at all?

2. If yes, how should the joint arrangement be classified?

Does a joint arrangement exist at all?

You know the drill. We have to first define a joint arrangement in line with what the applicable accounting standard says. Here we go! With respect to IFRS 11:

A joint arrangement is a contractual arrangement that gives two or more parties joint control of the arrangement.

Where the emphasis is, that is where the secret lies. There has to be a contractual agreement that is enforceable on all parties and there has to be joint control before a joint arrangement can exist at all.

The above implies that there can be no joint arrangement if the investors don’t have unanimous agreement on the relevant activities of the investee. Relevant activities could be any of the following:

• Selling and purchasing of goods or services
• Managing financial assets
• Selecting, acquiring or disposing of assets
• Researching and developing new products or processes
• Determining a funding structure or obtaining funding.

Once we are able to establish that there is a contractual arrangement and a joint control, then we can say a joint arrangement exists.  

How should the joint arrangement be classified?

A joint arrangement can be classified into either of these two depending on some factors that we will describe shortly:

1.    Joint operation

2.    Joint venture

Joint operation

A joint operation is a joint arrangement whereby the parties that have joint control of the arrangement have rights to the assets, and obligations for the liabilities, relating to the arrangement. Those parties are called joint operators.

Joint venture

A joint venture is a joint arrangement whereby the parties that have joint control of the arrangement have rights to the net assets of the arrangement. Those parties are called joint venturers.

You can see the difference already. Yes! 

If a joint arrangement is not structured through a separate legal entity, it is always accounted for as a joint operation. This simply means if two or more parties come together to set up a business, but does not create a separate legal entity for such business, it is automatically a joint operation.

For example, if an oil company that deals in upstream activities (extraction) agrees with a company that deals in downstream activities (distribution) to enter into a transaction in which the company dealing in upstream activities extracts and refines the crude oil and the company dealing in downstream activities distributes the refined oil to customers and then both companies share profit at an agreed percentage, this is a joint operation as no legal entity was created through the joint arrangement.

However, if two oil companies that deal in upstream activities create a separate legal entity to operate its downstream activities, there may be a joint venture or joint operation, depending on other facts and circumstances such as structure, legal form and contractual agreement.

Newsflash!!! For practical examples and to watch an explanatory video on the difference between joint operations and joint ventures, see below YouTube video. 

PS: Among other examples within, there's an interesting practical example for you to solve at the end of the video. Join the conversation in the comment section of the video.

 I will be happy to receive any questions you may have that are not addressed in the article/video.

Share in the comment section any practical example that you have encountered on your job for others to learn.

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Written by:

Adedamola Otun

For: IFRS IS EASY