New joint venture standard means significant change to reported balance sheets
Friday, 13 May 2011 — Industries that commonly form joint venture entities to deliver projects, such as mining, oil and gas, real estate and construction may be impacted by the new standard on joint arrangements released today by the International Accounting Standards Board (IASB). For some real estate and construction companies this will result in an expanded balance sheet and income statement, where previously one net result was reported. Conversely, for some in the mining and resources sector the reverse may apply.
The new standard, Joint Arrangements (IFRS 11), deals with arrangements where there is joint control of an entity by two or more companies. The current accounting approach is usually determined by the structure of the arrangement and management. The new joint arrangement standard focuses on the nature of the rights and obligations of the arrangement.
According to Lynda Tomkins, Ernst & Young’s National IFRS leader, “The joint arrangements affected will be primarily those conducted through an entity. This new standard removes the company’s choice to account for a joint venture as a one-line investment or take up their share of the underlying assets and liabilities. It now requires an assessment of the rights and obligations of each party, which will determine the appropriate accounting.”
A benefit of this approach is financial reporting consistency. Removing the choice of accounting means that arrangements of the same nature will be accounted for in the same manner by all companies and parties to the arrangement. This improves the comparability of financial results and financial position between companies.
As many joint venture arrangements in the Australian construction and real estate sector use the one-line investment accounting option, companies may need to change the way they present their financial statements, if the nature of the investment gives the parties a ‘direct’ right to the assets and obligation of the arrangement.
“Gearing ratios, gross margins and other key financial ratios will be impacted if companies have to take up their share of the underlying assets and liabilities, revenues and expenses of the joint arrangement to comply with the new standards.” Ms Tomkins says.
“In contrast, the mining and oil and gas sector often account for their joint arrangements by taking up a share of the underlying assets and liabilities, revenues and expenses. This accounting can only be continued if the arrangement gives the participants a direct share of the underlying assets and liabilities – which is often the case for unincorporated joint venture arrangements”
The one-line investment reporting option can only be used when a joint venture partner has an indirect right to the assets and liabilities rather than a direct right and obligation. Typically this will occur in those arrangements where the partner does not have any liability beyond their investment into the arrangement, and where creditors and other financiers do not have any right of recourse to the participants themselves.
While the standard does not come into effect until 1 January 2013 all companies operating under IFRS and involved in joint venture arrangements will need to reassess their arrangements, determine how they will be affected and begin planning for adoption of these standards.
“Companies will need to factor in the time required to gather data and potentially change business processes and controls,” says Ms Tomkins.
“The joint venture standard is just one of five major IFRS change projects coming in the next 12 months. Each has its own complexity and industry impacts, will be implemented in a short timeframe, and will have a fundamental impact on business operations. It’s big, it’s complex and it’s coming our way.”
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