Module 6 - Joint Arrangements PDF

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Summary

Introduction/Overview This module demonstrates an understanding about joint arrangement, essential elements of joint arrangement, types of joint arrangement, accounting for joint operation transactions, and relevant provisions of the PRFS for SMEs as well as Section 15 Investment in Joint Ventures.R...

Description

1. Introduction/Overview This module demonstrates an understanding about joint arrangement, essential elements of joint arrangement, types of joint arrangement, accounting for joint operation transactions, and relevant provisions of the PRFS for SMEs as well as Section 15 Investment in Joint Ventures. Related standards: PFRS 11 Joint Arrangements PAS 28 Investments in Associates and Joint Ventures Section 15 of the PFRS for SMEs 2. Learning Outcomes 1. 2. 3. 4.

Define a joint arrangement and state its characteristics. Difference between a joint operation and joint venture. Account for joint operations. Describe the accounting requirements for joint ventures

3. Joint Arrangement Definition of Joint arrangement Joint arrangement is "an arrangement of which two or more parties have joint control." (PFRS 11.4) Essential elements in the definition of joint arrangement: a.

Contractual arrangement

b.

Joint control

Contractual arrangement A contractual agreement for the sharing of joint control over an investee distinguishes an interest in a joint arrangement from other types of investments, such as investment in equity securities measured at fair value (PFRS 9), investment in associate (PAS 28), and investment in subsidiary (PFRS 3 and PFRS10). PFRS 11 is not applicable without such an agreement. The contractual arrangement may be evidenced in various ways, for example, by a contract, by minutes of discussions between the parties, or by inclusion in the articles or by-laws of the joint arrangement. Whatever its form, the contractual arrangement is usually in writing and deals with matters such as: a.

the activity, duration and reporting obligations of the joint arrangement;

b.

the appointment of the board of directors (or its equivalent) and the voting rights of the parties;

c.

d.

capital contributions by the parties; and the sharing by the parties of the output, income, expenses or results of the joint arrangement.

The contractual arrangement establishes joint control over the joint arrangement. Such a requirement ensures that no single party is in a position to control the activity unilaterally. Joint control 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." (PFRS 11.7) In contrast with significant influence and control, an investor obtains joint control over an investee through a contractual agreement with fellow investors. Financial arid operating decisions relating to the joint arrangement's activities require the consent of each of the parties sharing joint control. No single party obtains leverage over another in respect of voting rights over financial and operating decisions. Contrast joint control with the following: •

Significant influence is the power to participate in the financial and operating policy decisions of an investee but is not control or joint control over those policies.

•

Control is the power to govern the financial and operating policies of an investee so as to obtain benefits from it

Joint control exists when all the parties sharing joint control over the arrangement act collectively (together) in directing the activities that significantly affect the returns of the arrangement. An arrangement is considered a joint arrangement even if not all of the parties to the arrangement have joint control. It is sufficient that at least two of those parties share joint control. PFRS 11 distinguishes between: a.

parties that have joint control of a joint arrangement (referred to as joint operators or joint venturers — see discussion below), and

b.

parties that participate in, but do not have joint control of, a joint arrangement.

Ø Party to a joint arrangement is '"an entity that participates in a joint arrangement, regardless of whether that entity has joint control of the arrangement." (PFRS 11. Appendix A)

However, in the separate financial statements, investments in associates, subsidiaries and joint ventures are accounted for either: (a) at cost, (b) at fair value in accordance with PFRS 9, or (c) using the equality method. Examples: (PFRS 11.B28) Case 1 A, B and C has an arrangement whereby A has 50% voting rights, B has 30% and C has 20 %. The parties agreed that at least 75% of the voting rights are required to make decisions about the relevant activities of the arrangement

Analysis: The requirement that at least 75% voting rights is needed to make a decision imply that A and B have joint control over the arrangement because decisions cannot be made without both A and B agreeing.

Case 2: A, B, and C has an arrangement whereby A has 50% of the voting rights, B has 25% and C has 25%. The parties agreed that at least 75% of the voting rights are required to make decisions about the relevant activities of the arrangement.

Analysis: A, B and C collectively control the arrangement because to reach the 75% vote either A and B or A and C should agree. To be a joint arrangement, the parties would need to specify which combination of the parties is required to agree unanimously on decisions about the relevant activities of the arrangement. Case 3: A and B each has 35% of the voting of an arrangement; the remaining 30% is widely dispersed. Decision about relevant activities require a majority of the voting rights.

Analysis: A and B have joint control only if the contractual arrangement specifies that decisions require both A and B agreeing. This is because a majority vote can be reached either in the combination of A and other parties or B and other parties, i.e., A's 35% + at least 16% held by other investors or B's 35% + at least 16% held by other investors. ('Majority is 51% or more)

3.1. Types of Joint Arrangement Types of joint arrangement An entity is required to determine the type of joint arrangement in which it is involved. The types of joint arrangement are: 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 of the arrangement. Those parties are called joint operators.” (PFRS 11.15)

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." (PFRS 11.16)

b.

An entity applies judgment when determining the type of joint arrangement in which it is involved by: a.

Considering its rights and obligations arising from the arrangement.

b.

Assessing its rights and obligations in relation to the: i.

structure and legal form of the arrangement,

ii.

terms of the contractual agreement, and

iii.

other facts and circumstances.

Rights and obligations arising from the arrangement If the contractual arrangement confers to the parties that have joint control rights to the assets and obligations for the liabilities of the joint arrangement, the joint arrangement is a joint operation. The parties that have joint control are called joint operators. If the contractual arrangement confers to the parties have joint control rights to the net assets of the joint arrangement, the joint arrangement is a joint venture. The parties that have control are called joint venturers. Assessment of rights and obligations Structure and legal form of the arrangement a.

A joint arrangement that is not structured through a separate vehicle is a joint operation.

b.

A joint arrangement in which the assets and liabilities relating to the arrangement are held in a separate vehicle can be either a joint venture or a joint operation.

Ø Separate vehicle — "a separately identifiable financial structure, including separate legal entities or entities recognized by statute, regardless of whether those entities have a legal personality." (PFRS 11. Appendix A)

Examples: Case 1: A, B, and C, each engaged in the extraction of oil, agreed to acquired and jointly operate an oil pipeline. The parties will share equally in the pipeline’s acquisition and operating costs.

Analysis: The joint arrangement is a joint operation because it confers to the Parties rights to the assets and obligations for the liabilities of the joint arrangement. Case 2: A and B agreed to jointly manufacture and distribute a particular product. Each party will carry out different parts of the manufacturing process, bearing its own costs but will have an equal share on the revenues.

Analysis: The joint arrangement is a joint operation because it is not Structured through a separate vehicle (i.e., each party carries out a specific task using its own existing business).

Case 3: A and B entered into a joint arrangement to form Alphabets Corporation, which will manufacture materials required in A’s and B’s individual manufacturing processes. Each party will have 50% ownership interest in Alphabets Corporation. Alphabets will have its own assets, liabilities, equity, income and expenses.

Analysis: Alphabets Corporation (the 'separate vehicle') is a legal entity, separate and distinct from its owners. Accordingly, Alphabets' assets and liabilities are its own, rather than of its owners. This indicates that the joint arrangement confers A and B rights to the net assets of Alphabets, as opposed to specific assets and liabilities. The joint arrangement, therefore, is a joint venture. However, A and B can modify the features of the separate vehicle such that A and B will have rights to the assets and obligations for the liabilities of the separate vehicle. Such modifications can cause an arrangement to be a joint operation. (See next case.)

Terms of the contractual agreement and Other facts and circumstances Case 4 (adapted from PFRS 11.B32 Refers to case 3 above (Alphabets Corporation). In addition, it was further agreed that: A and B shall purchased all of Alphabet’s output in the ratio od 50:50. Alphabets cannot sell to third

a.

parties without A and B;s approval. Alphabets’ pricing policy is designed to cover only the operating costs. Thus Alphabets is intended to operate at a break-even level. b.

Analysis: The exclusivity of Alphabets' output to A and B reflects the dependence of Alphabets on A and B in generating cash flows. Therefore, A and B have an obligation to fund the settlement of Alphabets' liabilities. Moreover, that exclusivity evidences A and B's rights to all the economic benefits of the assets of Alphabets. These additional facts and circumstances indicate that the arrangement is a joint operation. Case 5: (Adapted from PFRS 11.B32) See Cases 3 & 4. A and B change the contractual arrangement so that Alphabets is able to sell its output to third parties, resulting in Alphabets assuming demand, inventory and credit risks.

Analysis: The change in the facts and circumstances requires a reassessment of the classification of the joint arrangement. The change indicates that the arrangement is a joint venture. 3.2. Joint Operations Joint operations A joint operator recognizes its own. assets, liabilities, income and expenses plus its share in the joint operation's assets, liabilities, income and expenses. These items are accounted for under other PFRSs applicable to the particular assets, liabilities, income and expenses. Illustration 1: A and B agreed to combine their operations, resources and expertise to jointly manufacture and sell a particular product. The joint operators will individually carry out different parts of the manufacturing process, bearing their own costs but will share equally in the revenues. The joint operation was complete, and thus terminated, during the year. The following were the transactions: •

A had sales of P200 and expenses of PIOO.

•

B had sales of P150 and expenses of P80.

Ø Financial reporting: The individual statement of comprehensive income of the entities will show the following: Entity A

Entity B

Sales [(200 + 150) x 50%}]

175

Expenses

(100)

Profit

75

Sales [(200 + 150) x 50%}]

175

Expenses

(80)

Profit

95

Illustration 2: A and B agreed to acquire and jointly operate an oil each will use to transport its own oil. The joint operators will share equally in the pipeline's acquisition and operating costs. The acquisition cost was P100M and the operating costs were P30M. A and B had total sales of P120M and P150M, respectively. Ø Financial reporting: The individual financial statement of the entities will show the following: Entity A

Entity B

Statement of financial position

Statement of financial position

PPE (oil pipeline) 100M x 50%

50M

Statement of profit or loss

PPE (oil pipeline) 100M x 50%

50M

Statement of profit or loss

Sale

120M

Sale

150M

Expenses Profit

(15M ) 105M

Expenses Profit

(15M ) 135M

Accounting for joint operation transactions Separate books of accounts (i.e., journal and ledger) may or may not be used for a joint operation. No separate records are maintained Separate books of accounts may not be used most especially when the joint operation is relatively short-lived. When separate records are not maintained, joint operation transactions involving income and expenses are recorded in each of the joint operators' individual books using the "Joint Operation " account (which is like the 'income summary' account). Joint Operation

·

Merchandise contribution

xx

xx

Merchandise withdrawals

·

Purchased & freight- in

xx

xx

Purchase returns & discount

·

Sales return & discount

xx

xx

Sales and other income

·

Expenses

xx

xx

Unsold merchandise, if any

Nominal accounts with normal debits balances are placed on the debit side; those with normal credit balances are placed on the credit side. A credit balance in the T- account represent profit; a debit balance represent loss. Unsold merchandise (ending inventory) is placed on the credit side to reflect ‘cost of goods sold’ (i.e., mdse. Contribution/beg. + purchased + freight-in on the debit side less ending inventory on the credit side equals cost of goods sold).

In addition, personal accounts are used. A personal account is a receivable from, or a payable to, a joint operator. Example: A and B's joint operation has no separate records. To record the transactions of the joint operation, A and B will each open a Joint Operation account in their respective books. In addition, A will open a "Receivable from B" and/or a "Payable to B " account. B will do the same his books. Alternatively, account titles such as "Account with A" or "Account with B" or simply "A co." or "B Co. " may also be used. A credit balance in such account represents a payable; a debit balance represents a receivable. At any point of time, the Joint Operation accounts in A's and B's books should tally. If not, reconciliation shall be made. One or more joint operators may act as the manager who will oversee the day-to-day operations of the joint operation. Managers are usually paid a fee for such duties. Management fees are treated as expense by the joint operation and as income by the manager. The manager records any asset (other than merchandise) and any liability he receives/incurs on behalf of the joint operation using regular accounts but labeled as 'JO', e.g., "Joint operation Cash" ('JO-Cash'), 'JOaccounts receivable', and 'JO-accounts payable', The manager maintains these accounts in his 'own books in addition to the Joint Operation and personal accounts. The Joint Operation, personal accounts, and other JO accounts are maintained alongside a joint operator’s regular accounts, but these are closed when the joint operator prepares its general-purpose financial statements.

Illustration: Joint operation profit & Cash settlement A, B and C’s joint operation had the following transaction; a.

A contributed cash P100 and inventory costing P200

b.

B contributed inventory costing P400. B paid freight of P20 on the transfer;

c.

C made purchased of P100 using A’s cash contribution.

d.

C paid expenses of P200 using his own cash.

e.

C made total sales of P800. All inventories were sold expect one-half of those contributed by B. the unsold inventory was charged to C on the settlement of the joint operation.

The joint operators agreed on the following: a.

C, the appointed manager, is entitled to a salary of P30 and a bonus of 25% of profit after salary and bonus.

b.

Interest of 10% is allowed on A’s and B’s capital contributions.

c.

Any remaining profit or loss is shared equally,

Solutions: Requirements (a): Profit or loss after salary and bonus Joint operation Mdse. Contribution of A & B (a) Purchased Expenses

620 100 800 Sales 200 210 Unsold merchandise 9b0 90 Profit before salary and bonus

(a)

A: 200+ B: 400 + 20 freight = 620

(b)

(B: 400 + 20 freight) x 1/2 = 210

Profit before salary and bonus

90

C’s salary

(30)

C’s bonus

(12)

Profit after salary and bonus

48

•

Alternative solution: (90 — 30) + 125% = 48

Recall that a joint operation recognizes management fees as expenses. Thus, even if the requirement in the problem is stated differently, say "profit for the year,' the answer would still be P48. The interests on capital contributions, however, are used only for P/L allocation and are not expenses. Why?......because capital

contributions are considered equity, only interests on liabilities are recognized as interest expenses. Requirement (b): Cash settlement A

B

C

Profit before salary and bonus

Total 90

Allocation 1.

Salary

30

30

2.

Bonus (see requirement ‘a’

12

12

3.

Interest (300 x 10%) and (420 x 10%)

4.

Allocation of remaining profit

30

42

72

(90 – 30 – 12 – 72) = -24; (-24/3)

(8)

(8)

(8)

(24)

As allocated

22

34

34

90

Interest in Joint Operation whose activity constitutes a business An entity that acquires an interest in a joint operation whose activity constitutes a business shall account for its share as a business combination. A business "is an integrated set of activities and assets that is capable of being conducted and managed for the purpose of providing a return in the form of dividends, lower costs or other economic benefits directly to investors or other owners, members or participants." (PFRS 3. Appendix A) Financial Reporting: C Co.'s statement of financial position will include C Co.'s shares in JO X's assets and liabilities and the compute...