The IASB s Research Project on Joint Ventures led by the AASB Ahmad Hamidi-Ravari, Project Manager, Australian Accounting Standards Board Abstract In April 2003, the IASB asked the AASB to take responsibility for a broad and long-term research project on joint venture arrangements. With the adoption of IFRSs in Australia, the role of the AASB in research projects is an important way in which Australia can influence the deliberations of the IASB. The joint ventures research project has the added feature of helping to enhance cooperation with other standard setters in the region with a view to influencing such deliberations from a regional perspective. This paper outlines the project and reports on the initial stages of the project work. 1
Introduction The last two decades have witnessed massive organisational changes profoundly affecting business structures. The need for continued growth in a diversified global market is causing large corporations to reorient their business structures using multiple joint arrangements. Joint ventures are seen as providing possibilities for joint economic activity with a view to improving financial rewards while sharing risk, utilising the different specialised skills of participants and achieving greater economies of scale. The trend in creation of innovative structures for joint economic activity demands continuous vigilance on the part of the accounting profession and, most of all, standard setters. Joint venture structures have become varied and more complex and a host of drivers are continuously pushing the limits of imagination in devising structures. The IASB projects The IASB has two projects in relation to accounting for interests for joint ventures. These projects pursue different objectives: The convergence project In September 2002, the IASB agreed to add a convergence project to its active agenda. The objective of the project is to reduce differences between IFRSs and US GAAP. The project is a joint project with the FASB. The convergence project is a short-term project although it may draw on the early results of the research project (see below) in relation to issues of common concern to both projects. The research project In April 2003, the IASB asked the AASB to take responsibility for a broad and long-term research project on joint venture arrangements. The project which is expected to result in a revised IAS 31 (and AASB 131) is to: consider improving the distinction between control of an investment and control of the underlying assets and liabilities. The distinction is to be based on the substance of an arrangement and not on whether a legal entity exists. However, it was also noted that the legal structure of a joint venture might have significant implications for the substance of an arrangement; 2
(c) examine whether there are three types of arrangements under which a venturer controls: (i) underlying assets and liabilities; (ii) interests in underlying assets and liabilities; and (iii) rights to share in the activities of an entity; and consider whether the equity method is suitable for accounting for interests in joint ventures and the usefulness of the equity accounting method in general. Alternatives of the fair value method, the expanded equity method and the gross equity method are to be examined. The focus of this article is the IASB s research project. The project plan In 2003, the AASB formed a Joint Ventures research project team comprising staff of the standard-setters in Australia, Hong Kong, Malaysia and New Zealand. The research team met for the first time in February 2004, and developed a draft project plan. The project plan, which was presented at the April 2004 National Standard Setters meeting, outlined recommendations for the research project s scope, the research methods to be used and the research timetable. The plan that was approved for the research project by the IASB includes three phases: A definition phase the structures of joint ventures the substance of joint ventures and the effect of legal form on their substance the definition of a joint venture: (c) the concept of joint control; contractual arrangements as the basis for joint ventures; and the concept of an entity. An accounting treatment phase the appropriate method of accounting by venturers for interests in joint ventures A disclosure phase disclosures by venturers about interests in joint ventures The project plan foresees the publication of a Discussion Paper and, when the IASB decides to move to an active phase, an Exposure Draft and a revised Standard. 3
A joint venture survey was seen as a first step to gather information on a number of key issues that were instrumental in progressing the project. For this purpose, a questionnaire was posted on the AASB website in July 2004. The survey, which pledged confidentiality, attracted the attention of 54 respondents worldwide and provided useful information on the following issues: (c) (d) (e) (f) (g) (h) (i) (j) the industries in which joint arrangements are used; legal instruments underlying the various joint arrangements; veto rights and joint control; legal forms used for joint arrangements; whether the investor has an active participation in the arrangement; whether substance and form of the arrangements differ; effect of form on substance and characteristics affected by the form; drivers for the choice of a particular form for an arrangement; what the investor controls or has responsibility for; and accounting treatments currently being used for interests in joint arrangements. The consultation process The Joint Ventures Survey was the first stage in the consultation process. Constituents will be consulted as part of the due process when a Discussion Paper is published and when an Exposure Draft is released. Continuous consultation with the profession and industry is primarily taking place through an advisory panel stationed in Australia involving members from the Big 4 accounting firms and industry. Users of financial reports will be consulted through a newly-formed AASB user focus group. Joint Venture team members separately consult with industry and the accounting profession in their own jurisdictions. Apart from the consultation with the advisory panel, views are also sought directly from industry and other interested parties as the project progresses. Issues currently being considered Definition of a joint venture The need for a definition of a joint venture arises from the fact that it is perceived as a unique type of arrangement requiring a unique accounting treatment by the participant that holds an 4
interest in such an arrangement. One important feature of such arrangements, as depicted by the accounting literature, is that participants have the right to share control over the activities of the arrangement. This does not give the participant the ability to control the assets, liabilities or activities of the arrangement, as is the case in a parent-subsidiary relationship, but gives the participant in the joint venture more influence than a typical non-controlling investment. Joint control is seen as the factor that separates joint ventures from other forms of investment such as subsidiaries and associates. There are currently differences between the definitions of a joint venture in various jurisdictions. Therefore, some arrangements satisfying the definition of a joint venture in one jurisdiction may not be classified as a joint venture in another. Differences in definitions have implications for the comparability of accounting treatments of interests in joint ventures. Removing the differences between the definitions of a joint venture and subsequent adoption of a common definition across jurisdictions is the first step towards improving comparability. However, the existence of a common definition may not ensure comparability by itself. The consistent interpretation and application of the definition is also of significance. The application of substance over form can help reduce inconsistencies in the interpretation and application of the definition of a joint venture. Other issues affecting comparability are the differences in accounting treatments and the nature and extent of disclosures in various jurisdictions. With a common robust definition of a joint venture in place, the issue of incomparability arising from diverse accounting treatments can be addressed more effectively. It is arguable that the differences between current definitions worldwide can be overcome if a common set of principles are applied in the analysis of the elements of the definitions, and a substance over form approach is employed in the consideration and classification of joint arrangements. Consensus on a common set of principles to be used should be based on conceptual frameworks. Although there are some, mainly minor, differences in such frameworks across jurisdictions, the commonality in the building blocks of the frameworks, the increasing global acceptance of IFRSs and convergence efforts on conceptual issues provide useful tools for the analysis and classification of joint arrangements with a view to developing a common definition of a joint venture. 5
Classification of joint economic activities In pursuit of arriving at a definition of a joint venture, it would be useful to explore ways that various joint economic activities may be classified. A possible way of classifying joint economic activities is by reference to the way participants are exposed to the risks and rewards of the arrangement: A mechanical combination of resources occurs when resources are combined together in such a manner that the risks and rewards of the resources contributed can directly be traced to the contributing participant. An organic combination of resources occurs when the resources for joint economic activity are brought together in such a manner that the risks and rewards of the resources contributed can no longer be directly traced to the contributing participant. Some of the features invariably exhibited by joint arrangements involving a mechanical combination are: (c) (d) (e) (f) (g) (h) (i) The arrangement does not constitute a separate decision-making identity. The participants seek to further their own economic activities through the joint arrangement. The participants provide services to the joint arrangement that are not in substance different from the services that a contractor would provide. The arrangement is an agent of participants or a vehicle to facilitate their individual activities. Each participant uses its own resources, incurs its own expenses and liabilities and raises its own finance. Participants have direct interests in the assets of the arrangement including undivided interests. The arrangement s role is that of a manager of the assets and liabilities on behalf of the participants. The arrangement is a cost and revenue sharing arrangement or acts as the conduit for passing on expenses and revenues to the participants. The arrangement is merely an extension of each participant s economic activities with no access to the market in its own right. 6
(j) (k) Each participant progresses its own economic activity independently of the others within the structure. It is often possible to segregate the activities of the arrangement so that each participant's results can be separately determined. Distinguishing features of arrangements involving an organic combination of resources include: (c) (d) (e) (f) The joint arrangement carries on an economic activity of its own using its own resources to achieve its own objectives. The joint arrangement has a separate decision-making identity. The arrangement controls the resources in its own right and not on behalf of the participants. Participants do not control or jointly control the individual assets of the arrangement rather they control an interest in the arrangement. The arrangement depicts an economic activity that is separate from participants. The return from the economic activity reflects a joint return. Joint venture as an entity The above classification may provide a dividing line between joint arrangements that are joint ventures and those that are not. Provided joint control exists, joint arrangements involving an organic combination of resources can be classified as joint ventures. The attributes of such arrangements give them an entity identity separate from their participants. The concept of an entity has been considered elsewhere in joint venture accounting literature. It goes beyond the legal entity concept and may include unincorporated structures. For example, the UK Accounting Standards Board s FRS 9 Associates and Joint Ventures defines a joint venture as an entity in which the reporting entity holds an interest on a longterm basis and is jointly controlled by the reporting entity and one or more other venturers under a contractual arrangement. Similarly, the G4+1 paper Reporting Interests in Joint Ventures and Similar Arrangements (1999) defines a joint venture as an enterprise that is jointly controlled by the reporting enterprise and one or more other parties. 7
Joint control Joint control is a key element in determining the existence of a joint venture. This is clearly demonstrated by the fact that most accounting standards define a joint venture with reference to the definition of joint control. Joint control separates joint ventures from other forms of investment such as subsidiaries and associates. Veto rights It is possible to have control shared between participants where they do not have equal shares in the joint arrangement. Joint control in such cases normally arises through the right of each participant to veto the financial and operating policies being advocated by the others. Thus, it would be possible to have a joint venture whereby the participants interests are in the ratio of say 25:35:40 provided participants with joint control hold veto rights. However, it is important to establish beyond doubt that the veto right can be exercised in practice and there are no override mechanisms in place making such rights ineffective. In some cases an investor may appear to qualify as a parent based on its share in the joint venture but contract clauses such as veto rights given to minority investors, or other restrictions, ensure joint control over the arrangement. Veto rights that lead to joint control distinguish a venturer from a minority shareholder in a company, because in the latter case the investor is subject to the majority rule. Contractual arrangements Written contractual arrangements are generally in place to provide for joint control. It has been argued that constructive arrangements, such as those arising from the actions of venturers, may equally be a sufficient basis for joint control. For example, if two shareholders each own 50 percent of the common voting shares of an entity and there is no other agreement or factor that effectively gives either of them control, neither has the power to control the entity and instead each must consent to decisions essential to the operation of the entity. However, some argue that in such cases, it is likely that other documents (such as the articles of association of the investee) are in place to ensure joint control. Tentative definitions To have a true joint venture, the joint arrangement needs to be carrying on an economic activity of its own. Such a feature, which is consistent with a separate decision making identity, makes the joint arrangement an entity. Therefore, an entity may tentatively be 8
defined for joint venture accounting purposes as an incorporated or unincorporated structure carrying on an economic activity of its own with a view to economic benefit. A joint venture exists if the venturers have joint control. A reporting entity jointly controls an entity with one or more other venturers when no venturer unilaterally controls that entity but all venturers together do so under a contractual arrangement and the strategic financial and operating decisions relating to the economic activity undertaken by the entity require the unanimous consent of the venturers. Thus, a joint venture may tentatively be defined as a joint arrangement that is an entity and is jointly controlled by the reporting entity and one or more other venturers under a contractual arrangement. Substance over form Often, the legal form will adequately represent the commercial substance of transactions. However, sometimes substance and form differ. Some complex arrangements, when reported in accordance with their precise legal form, may differ significantly from their underlying commercial substance. Applying substance over form involves the application of professional judgement to determine the true nature of an arrangement for communication to users in a useful manner. The literature on joint ventures indicates that there are various drivers for investors to use a particular structure in order to draw on the advantages of that structure and minimise respective disadvantages. This may lead to form not conforming with substance, such that the distinction between entity and non-entity joint arrangements may become blurred. The application of substance over form in relation to joint arrangements needs to be considered from two viewpoints. The first consideration relates to whether a joint arrangement conforms to the definition of a joint venture. The second set of considerations relates to determining the substance of the transactions that involve the contribution of assets to joint arrangements and identifying the assets that a participant in a joint arrangement controls and the liabilities that it is responsible for. Co-dependencies There are co-dependencies between various projects that the IASB is progressing. For example the research project on Leases has proposed a contractual rights and obligations approach instead of a risk and rewards approach previously adopted in lease accounting. The 9
research team monitors developments in other IASB projects that might have implications for the joint ventures research project. Accounting treatment and disclosure Currently the project is in its definition phase. Clearly the results of this phase, once finalised and deliberated by the IASB, will be instrumental in determining the nature and direction of work on the second and third phases, which are the accounting treatment of interests in joint ventures and disclosures. Some preliminary work on the second phase is concurrently being carried out with a view to speeding up the research process. Readers who may wish to make an input to the process, please forward any comments to the author at ahamidi@aasb.com.au. References Accounting Standards Board. (1997). FRS 9 Associates and Joint Ventures. November. Australian Accounting Standards Board. (2004). AASB131 Interests in Joint Ventures. July. G4+1 (1999). Reporting Interests in Joint Ventures and Similar Arrangements. October International Accounting Standards Board. (2002). IASB Update, September.. (2003). IASB Update, April.. (2003). IAS 31 Interests in Joint Ventures. December.. (2004). IASB Update, April. Joint Ventures Research Team. (2004). Joint Ventures Survey Questionnaire, July. 10