Ch24 sm leo 10e - Financial accounting textbook solutions PDF

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Financial accounting textbook solutions...

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Solutions Manual to accompany

Company Accounting 10e prepared by

Ken Leo John Hoggett John Sweeting Jeffrey Knapp Sue McGowan

© John Wiley & Sons Australia, Ltd 2015

Solutions manual to accompany Company Accounting 10e

Chapter 24 – Joint arrangements REVIEW QUESTIONS 1.

What is a joint arrangement?

AASB 11 states: 4. A joint arrangement is an arrangement of which two or more parties have joint control. 5. A joint arrangement has the following characteristics: (a) The parties are bound by a contractual arrangement (see paragraphs B2–B4). (b) The contractual arrangement gives two or more of those parties joint control of the arrangement (see paragraphs 7–13). 6. A joint arrangement is either a joint operation or a joint venture.

2.

How does a joint arrangement differ from an associate?

An associate exists when an investor has significant influence over another entity. A joint arrangement exists when an investor has joint control over another entity. An investor does not need to have an arrangement with another entity in order to have significant influence whereas to have joint control there must be two or more parties who have joint control.

3.

What is meant by joint control?

See AASB 11 para 7 and Appendix A. Joint control is the contractually agreed sharing of control of an arrangement, which exists only when decisions about the relevant activities require the unanimous consent of the parties sharing control. The key element of joint control is the sharing of control. In other words, there must be at least two investors who have shared control of the investee.

4.

How does joint control differ from control as used in classifying subsidiaries?

Under AASB 10: An investor controls an investee when the investor is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee.

There are three investor-investee relationships which are based on different levels of control: Relationship Parent - subsidiary Investor-associate Joint arrangement - investee

Level of control Dominant control Significant influence Joint control

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Chapter 24: Joint arrangements

With a subsidiary there can be only one parent. With joint control there needs to be at least 2 entities that share control.

5.

How does a joint venture differ from a joint operation?

The classification of a joint arrangement into either a joint operation or a joint venture depends on the rights and obligations of the parties to the arrangement. 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. 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. (AASB 11, paragraphs 15 and 16) 6.

What are the key steps in classifying a joint arrangement into joint ventures and joint operations?

The key element in the classification of a joint arrangement is the rights and obligations of the parties to the arrangement. For a joint operation the rights pertain to the rights and obligations associated with individual assets and liabilities, whereas with a joint venture, the rights and obligations pertain to the net assets, that is the investment in net assets. See AASB 11 para 14. The assessment of the classification of a joint arrangement requires judgement. The assessment of the rights and obligations in an arrangement involves analysing four factors: 1. the structure of the arrangement 2. the legal form of the arrangement 3. the terms agreed to by the parties in the contractual arrangement, and 4. any other relevant facts and circumstances. See AASB 11 para 17 and figures 24.3 and 24.5 in the text.

7.

How are joint ventures accounted for?

With a joint venture, the joint venturers have an interest in the investment in the joint arrangement. The accounting for this interest is done by application of the equity method in accordance with AASB 128 Investments in Associates and Joint Ventures. 8.

How are joint operations accounted for?

The key feature of a joint operation is that the joint operator has an interest in the individual assets and liabilities of the joint operation. In the situation where the joint operation produces an output which is distributed to the joint operators, the joint operator will receive a share of the output of the joint operation as well as be responsible for a share of the expenses of the operation that are not capitalised into the cost of the output. Hence each joint operator needs to recognise in itsown accounts: (a) its share of any jointly held assets (b) its share of any jointly held liabilities (c) its revenue from the sale of any output received from the joint operation (d) its share of any revenue from the sale of any product that is jointly constructed by the joint operators (e) its share of any expenses incurred by the joint operation (f) its expenses incurred in construction of a joint product

© John Wiley and Sons Australia Ltd 2015

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Chapter 24: Joint arrangements

CASE STUDIES Case study 1

Classification of joint arrangements

In its 2012 annual report (p. 122), Paladin Energy Ltd disclosed the following policy note: (p) Interests in Jointly Controlled Assets The Group has interests in joint ventures that are jointly controlled assets. A joint venture is a contractual arrangement whereby two or more parties undertake an economic activity that is subject to joint control. A jointly controlled asset involves use of assets and other resources of the venturers rather than establishment of a separate entity. The Group recognises its interest in jointly controlled assets by recognising its interest in the assets and the liabilities of the joint venture. The Group also recognises the expenses that it incurs and its share of the income that it earns from the sale of goods or services by jointly controlled assets. Required Discuss whether Paladin is likely to have interests in joint ventures or joint operations. The key phrase in this Note is “rather than establishment of a separate entity”. One of the key elements of classification is whether or not the joint arrangement is structured through a separate vehicle. If a joint arrangement is NOT structured through a separate vehicle then the arrangement is classified as a joint operation. In this example, Paladin is likely to have interests in joint operations. Paladin would recognise its share of any jointly controlled assets, liabilities revenues and expenses. Note that Paladin recognises the expenses it incurs and its share of the income from the sale of goods or services produced from the jointly controlled assets.

Case study 2

Classification of joint arrangements

In Note 1(b) of its annual report for the period ending 31 December 2012 (p. 148), Rio Tinto Ltd reported that it had interests in both jointly controlled entities and jointly controlled assets and that different accounting methods were used for these two items. The Note stated: Jointly controlled entities (JCEs): A JCE is a joint venture that involves the establishment of a corporation, partnership or other entity in which each venturer has a long term interest. JCEs are accounted for using the equity accounting method. Jointly controlled assets (JCAs): JCAs do not involve the establishment of a corporation, partnership or other entity. A JCA is a joint venture in which the venturers have joint control over the assets contributed to or acquired for the purposes of the joint venture. This includes situations where the participants derive benefit from the joint activity through a share of the production, rather than by receiving a share of the results of trading. The Group’s proportionate interest in the assets, liabilities, revenues, expenses and cash flows of JCAs are incorporated into the Group’s financial statements under the appropriate headings. Required Write a report explaining the classification of joint arrangements and the need for different accounting methods. Use the Rio Tinto Note to explain your answer.

© John Wiley and Sons Australia Ltd 2015

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Chapter 24: Joint arrangements

Having determined that a joint arrangement exists it is then necessary to classify it. There are two types of joint arrangements, namely joint ventures and joint operations: - a joint operation: an arrangement in which the parties that have joint control have rights to the assets and obligations for the liabilities relating to the arrangement. These parties are called joint operators. - a joint venture: the parties that have joint control have rights to the net assets of the arrangement. These parties are called joint venturers. The key element in the classification of a joint arrangement is the rights and obligations of the parties to the arrangement. For a joint operation the rights pertain to the rights and obligations associated with individual assets and liabilities, whereas with a joint venture, the rights and obligations pertain to the net assets, that is the investment in net assets. The assessment of the classification of a joint arrangement is not straight-forward, it requires judgement. The assessment of the rights and obligations in an arrangement involves analysing four factors: 1. the structure of the arrangement 2. the legal form of the arrangement 3. the terms agreed to by the parties in the contractual arrangement, and 4. any other relevant facts and circumstances. Joint ventures are accounted for by using the equity method while a joint operation is accounted for by the recognition of the joint operator’s share of the assets, liabilities, revenues and expenses of the joint operation. With Rio Tinto, the JCEs involve the establishment of a separate entity i.e. the joint arrangement is structured through a separate vehicle. Note figure 29.2 in the text. The other 3 steps noted above then have to be analysed to see if a joint venture exists. Rio Tinto classifies JCEs as joint ventures and applies the equity method of accounting. With JCAs, there is no separate vehicle established. Hence these are joint operations. These are accounted for by recognition in the financial statements of the Group of the Group’s proportionate share of the assets, liabilities, revenues, expenses and cash flows of the JCAs.

Case study 3

Classification of a joint arrangement

Falls Ltd and Creek Ltd decided to jointly undertake the manufacture of an electric car. They formed Silver Ltd, which will manufacture the car. Falls Ltd and Creek Ltd provide the various parts for the manufacture of the car, which is assembled by Silver Ltd. Falls Ltd and Creek Ltd each hold 50% of the voting rights in Silver Ltd and receive 50% of the cars produced by Silver Ltd. Falls Ltd and Creek Ltd then sell the cars in their own geographic region. The constitution of Silver Ltd requires that the operations of the company must be in accordance with a business plan prepared annually, and to which both Falls Ltd and Creek Ltd both agree. Silver Ltd has six directors, with three being appointed by Falls Ltd and three by Creek Ltd. Required Evaluate whether a joint arrangement exists and how it should be classified. Does a joint arrangement exist? A joint arrangement is an arrangement of which two or more parties have joint control. The two main characteristics are: - the parties are bound by a contractual arrangement, and - the parties have joint control of the arrangement.

© John Wiley and Sons Australia Ltd 2015

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Chapter 24: Joint arrangements

The contractual arrangement in this case would be the constitution of Silver Ltd which would set out the rights and obligations of the owners, namely Falls Ltd and Creek Ltd. Falls Ltd and Creek Ltd each hold 50% of the voting rights in Silver Ltd. In the absence of any other agreement, this would mean that both parties would have to agree before any decision was made. Note the existence of the business plan which requires joint agreement, and note further the structure of the board – 3 directors from each company. Hence it would seem that joint control exists. Hence a joint arrangement exists. How should the joint arrangement be classified? Note firstly that a separate entity, namely Silver Ltd, is established. Hence it could be either a joint operation of a joint venture. However, the other factor to consider is that Silver Ltd produces cars. These cars, as output, are distributed to Falls Ltd and Creek Ltd who sell the cars in their own geographic regions. The profit is then generated by the owners of Silver Ltd subsequent to the receipt of the output from the joint arrangement. Silver Ltd does not make any profit or loss. It just produces output. The parties to the joint arrangement then have a right to substantially all the economic benefits of the assets held by the arrangement. Another feature of such an arrangement is that, as a result of the decision to supply the output of the joint arrangement to the parties themselves, there is no cash inflow to the joint arrangement from the sale of the product. The joint arrangement relies solely on the parties to the arrangement for the supply of cash to continue the operations of the arrangement as well as to pay for the liabilities incurred by the arrangement. The parties themselves are then responsible for the liabilities of the arrangement as the latter has no facility to be able to generate cash for the settlement of liabilities. These forms of arrangement are generally classified as joint operations.

Case study 4

Joint operators as managers

In its 2012 annual report (p. 177) Paladin Energy Ltd supplied the following information: The Angela Joint Venture is involved in the identification of and exploration for uranium resources on tenements to the south of Alice Springs in the Northern Territory, Australia. The joint venture is between Cameco Australia Pty Ltd (Cameco) 50% and Paladin NT Pty Ltd (PNT) 50% (PNT is 100% owned by Paladin) with Paladin as manager and operator of the joint venture. Required Discuss the possible accounting implications of one of the parties to the joint arrangement being appointed as manager of the joint operation, including the situation where that party receives a fee for the provision of such services. The appointment of one of the entities as manager does not affect the classification of the joint arrangement as it does not affect the joint control arrangement. The manager implements the jointly agreed upon decisions. Where one of the entities acts as manger it is common for the joint operation to pay a management fee to the joint operator for its management services.

© John Wiley and Sons Australia Ltd 2015

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Chapter 24: Joint arrangements

In accounting for these payments, the joint operation pays cash to a joint operator, with the cost of the service being capitalised into work in progress and inventory produced by the joint operation. For a joint operator that does not supply the service there are no accounting adjustments necessary because of the transaction. For the joint venturer that does supply the service, normally it would incur a cost to supply the service and earn a profit on the supply of that service. In accounting for its interest in the joint operation, the operator supplying the service has to consider the following:  As with supplying assets other than cash as part of the initial contribution, a joint operator cannot earn a profit on supplying services to itself.  As the joint operation capitalises the amount paid to the operator into the cost of work in progress and inventory, an adjustment is necessary to the inventory related accounts of that operator because the cost of these items to the operator supplying the services is less than that to the other operator(s).

Case study 5

Existence and classification of a joint arrangement

The Chinese mining company Changchun Mining Ltd and the Australian mining company Gold Rush Ltd have agreed to set up a separate company, Dragon Gold Ltd, to mine for gold in Australia. The Australian government has issued permits to the Australian company to mine for gold in specified areas of Australia. The companies have set up a joint operating agreement which contains the following provisions:  The assets and liabilities of Dragon Rush Ltd are those of that company and not of the parties owning shares in Dragon Rush Ltd.  Dragon Rush Ltd has a board of directors that will consist of six persons, three provided by each of Changchun Mining Ltd and Gold Rush Ltd. Each of these companies has a 50% ownership in Dragon Rush Ltd. For any resolution to be passed by the board, there has to be unanimous consent of all directors.  Gold Rush Ltd will provide the management team for Dragon Rush Ltd for which a management fee will be paid by Dragon Rush Ltd. However, all budget matters and work programs have to be approved by the board of Dragon Rush Ltd.  The rights and obligations arising from the exploration development and production activities of Dragon Rush Ltd are to be shared by all parties to the joint arrangement. In particular, the parties will share in the production obtained from the mining activities and all costs associated with the work undertaken.  If cash is required for ongoing mining activities, the board of Dragon Rush Ltd may make calls on the parties owning shares in that company. Required Discuss whether a joint arrangement exists and whether it should be classified as a joint venture or a joint operation. Does a joint arrangement exist? A joint arrangement is an arrangement of which two or more parties have joint control. The two main characteristics are: - the parties are bound by a contractual arrangement, and - the parties have joint control of the arrangement. In this example there is an agreement between Changchun Mining Ltd and Gold Rush Ltd. The Board of Directors has 6 members with 3 from each company. There has to be unanimous consent of all directors. There is then a joint arrangement. How is the joint arrangement classified?

© John Wiley and Sons Australia Ltd 2015

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Chapter 24: Joint arrangements

The parties carry out the joint arrangement through a separate vehicle whose legal form confers separation between the parties and the separate vehicle. However, the parties have been able to reverse the initial assessment of their rights and obligations arising from the legal form of the separate vehicle in which the arrangement is conducted. They have done this by agreeing terms in the joint arrangement agreement that entitle them to rights to the assets (eg exploration and development permits, production, and any other assets arising from the activities) and obligations for the liabilities (eg all costs and obligations arising from the work programmes) that are held in Dragon Gold Ltd. The joint arrangement is thus classified as a joint operation. Both Changchun Mining Ltd and Gold Rush Ltd would recognise in their financial statements their own share of the assets and of any liabilities resulting from the arrangement on the basis of their agreed participating interest. On that basis, each party also recognises its share of the revenue (from the sale of their share of the production) and its share of the expenses.

Case study 6

Classification of a joint arrangement

Two smaller banks that operate in Austr...