Example 12.13: Construction and real estate sales
Two parties established a separate vehicle over which they have joint control. Neither the legal form nor the
contractual terms of the joint arrangement give the parties rights to the assets or obligations for the liabilities
of the arrangement. Other facts and circumstances are as follows:
• the purpose of the joint arrangement is to construct a residential complex for selling residential units to
the public;
• contributed equity by the parties is sufficient to purchase land and raise debt finance from third parties
to fund construction; and
• sales proceeds will be used as follows (in this priority):
• repayment of external debt; and
• remaining profit distributed to parties.
Analysis
Since there is a separate vehicle, and because neither the legal form nor the contractual terms of the joint
arrangement give the parties rights to the assets or obligations for the liabilities of the vehicle, the preliminary
analysis indicates that this is a joint venture. The fact that the parties are the only source of cash flows at
inception is not conclusive as to whether the facts and circumstances indicate that the parties have rights to
the assets, or obligations for the liabilities. That is, more information is needed and judgement will be required
in determining whether this is a joint venture or a joint operation.
Variation – The contributed equity is not sufficient to purchase the land and raise debt financing. There is an
expectation, or requirement, that the parties will have to contribute cash to the joint arrangement through a
series of cash calls. The fact that the parties are expected to be a source of cash flows is not sufficiently
conclusive to indicate that the parties have rights to the assets, and/or obligations for the liabilities. That is,
more information is needed before concluding if this is a joint venture or a joint operation.
The above example refers to the fact that there was third party financing available to
fund construction. In March 2015, the Interpretations Committee published an agenda
decision confirming that the availability of third party financing does not preclude the
classification as a joint operation (see 5.4.3.C below).
5.4.3
Interpretations Committee agenda decisions
In January 2013, the Interpretations Committee received several requests to clarify the
application of the ‘other facts and circumstances’ criterion in IFRS 11, which it discussed
during its meetings in 2013 and 2014. In March 2015, the Interpretations Committee
issued an agenda decision dealing with the following issues:
• how and why particular facts and circumstances create rights and obligations
(see 5.4.3.A below);
• implication of ‘economic substance’ (see 5.4.3.B below); and
• application of ‘other facts and circumstances’ to specific fact patterns
(see 5.4.3.C below):
• output sold at a market price;
• financing from a third party;
• nature of output (i.e. fungible or bespoke output); and
• determining the basis for ‘substantially all of the output’.
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arrangements
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5.4.3.A
How and why particular facts and circumstances create rights and
obligations
The Interpretations Committee noted the following regarding a joint arrangement that
is structured through a separate vehicle, whose legal form causes the separate vehicle
to be considered in its own right:3
(a) the assessment of other facts and circumstances is performed when there is no
contractual arrangement to reverse or modify the rights and obligations
conferred by the legal form of the separate vehicle through which the
arrangement has been structured;
(b) the assessment focuses on whether the other facts and circumstances establish, for
each party to the joint arrangement, rights to the assets and obligations for the
liabilities relating to the joint arrangement;
(c) parties to the joint arrangement have rights to the assets of the joint arrangement
through other facts and circumstances when they: [IFRS 11.B31-B32]
(i)
have rights to substantially all of the economic benefits (for example, ‘output’)
of assets of the arrangement; and
(ii) have obligations to acquire those economic benefits and thus assume the risks
relating to those economic benefits (for example, the risks relating to the
output); and
(d) parties to the joint arrangement have obligations for liabilities of the joint
arrangement through other facts and circumstances when: [IFRS 11.B14, B32-B33]
(i) as a consequence of their rights to, and obligations for, the assets of the joint
arrangement, they provide cash flows that are used to settle liabilities of the
joint arrangement; and
(ii) settlement of the liabilities of the joint arrangement occurs on a continuous basis.
A joint arrangement structured through a separate vehicle is classified as a joint
operation only when each party to the joint arrangement meets the above criteria and
therefore has both rights to the assets of the joint arrangement and obligations for the
liabilities of the joint arrangement through other facts and circumstances.
Although the Interpretations Committee decided not to add this issue to its agenda, it
observed that a joint arrangement could only be classified as a joint operation based on
other facts and circumstances, if an entity is able to demonstrate that:
(a) each party to the joint arrangement has rights and obligations relating to economic
benefits of the assets of the arrangement; and
(b) each party is obliged to provide cash to the arrangement through enforceable
obligations, which is used to settle the liabilities of the joint arrangement on a
continuous basis.
It is therefore irrelevant whether the activities of the separate vehicle are closely related
to the activities of the parties on their own, or whether the parties are closely involved
in the operations of the arrangements. [IFRS 11.BC43].
In July 2014, the Interpretations Committee discussed the classification of a specific
type of joint arrangement structure, established for a bespoke construction project for
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delivery of a construction service to a single customer. In this specific example, it
examined common features of ‘project entities’ with regard to assessing ‘other facts and
circumstances.’ The staff analysis listed several common features of ‘project entities’
that would not, by themselves, indicate that the parties have rights to the assets and
obligations for the liabilities, i.e. that the joint arrangement is a joint operation.4
• The separate vehicle has no workforce of its own.
• The separate vehicle is a limited-life entity that has been set up for a single project.
• The parties are responsible for delivering the goods or services to the customers.
• The parties are jointly or severally liable for all the debts of the separate vehicle.
• The customers of the separate vehicle are obtained through the commercial resources
of the parties (for example, their personnel, websites, classified ads, trade name).
• The parties finance any loss or cash needs of the separate vehicle, for example,
when there are budget overruns or delivery delays.
• Litigation arising from the operations of the separate vehicle is managed by the
parties or is accompanied by legal actions directly against the parties.
5.4.3.B Implication
of
‘economic substance’
The assessment of other facts and circumstances should focus on whether each party
to the joint arrangement has rights to the assets, and obligations for the liabilities,
relating to the joint arrangement. This raises questions about the role of the concept of
‘economic substance’ in the assessment of other facts and circumstances.
The Interpretations Committee determined that the assessment of other facts and
circumstances should be undertaken with a view towards whether those facts and
circumstances create enforceable rights to assets and obligations for liabilities (see 4.3.4
above). These obligations may be legal or constructive. Therefore, this evaluation should
include consideration of the design and purpose of the joint arrangement, its business
needs and its past practices to identify all obligations, whether legal or constructive.5
5.4.3.C
Application of ‘other facts and circumstances’ to specific fact patterns
The Interpretations Committee also explored the following four fact patterns and
considered how ‘other facts and circumstances’ should be applied in each of these cases:6
• Output sold at a market price – The sale of output from the joint arrangement to the
parties at market price, on its own, is not a determinative factor for the classification
of the joint arrangement. Instead, parties would need to exercise judgement and
consider whether the cash flows provided to the joint arrangement through the
parties’ purchase of the output from the joint arrangement at market price, along
with any other funding that the parties are obliged to provide, would be sufficient to
enable the joint arrangement to settle its liabilities on a continuous basis.
• Financing from a third party – If the cash flows to the joint arrangement from the
sale of output to the parties, along with any other funding that the parties are obliged
to provide, satisfy the joint arrangement’s liabilities, then third-party financing alone
would not affect the classification of the joint arrangement. This conclusion is
appropriate irrespective of whether the financing occurs at inception or during the
course of the joint arrangement’s operations. In this situation, the joint arrangement
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arrangements
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will, or may, settle some of its liabilities using cash flows from third-party financing,
but the resulting obligation to the third-party finance provider will, in due course, be
settled using cash flows that the parties are obliged to provide.
• Nature of output (i.e. fungible or bespoke output) – Whether the output that is
produced by the joint arrangement and purchased by the parties is fungible or
bespoke, is not a determinative factor for the classification of the joint
arrangement. IFRS 11’s main focus is on the existence of cash flows flowing from
the parties to satisfy the joint arrangement’s liabilities.
• Determining the basis for ‘substantially all of the output’ – The Interpretations
Committee noted that the economic benefits of the assets of the joint arrangement
would relate to the cash flows arising from the parties’ rights to, and obligations
for, the assets. [IFRS 11.B31-B32]. Therefore, the term ‘substantially all of the output’
is based on the monetary value of the output, instead of physical quantities.
5.4.4
Comprehensive example illustrating evaluation of facts and
circumstances
Example 12.14 below (summarised from Example 5 of IFRS 11) illustrates how the facts
and circumstances might indicate that the joint arrangement is a joint operation, even if
the legal form and contractual terms point towards the joint arrangement being a joint
venture. [IFRS 11.B32, Example 5].
Example 12.14: Modification of legal form and contractual arrangement by facts
and circumstances
A and B jointly establish a corporation (C) over which they have joint control. The legal form of C, an
incorporated entity, initially indicates that the assets and liabilities held in C are the assets and liabilities of
C. The contractual arrangement between the parties does not specify that the parties have rights to the assets
or obligations for the liabilities of entity C. Accordingly, the legal form of C and the terms of the contractual
arrangement indicate that the arrangement is a joint venture.
However, A and B agree to the following:
• A and B will purchase all the output produced by C in a ratio of 50:50.
• C cannot sell any of the output to third parties, unless A and B approve this. The purpose of the
arrangement is to provide A and B with the output they require, so sales to third parties are expected to
be uncommon and not material.
• The price of the output sold to A and B is set by the parties at a level that is designed to cover the costs
of production and administrative expenses incurred by C. The arrangement is intended to operate at a
break-even level.
Analysis
• The obligation of A and B to purchase all of the output produced by C reflects the exclusive dependence
of C upon A and B for the generation of cash flows and, thus, implicitly that A and B have an obligation
for the liabilities of C.
• The fact that A and B have rights to all of the output produced by C means that they are consuming, and
therefore have rights to, all of the economic benefits of the assets of C.
These facts and circumstances indicate that the arrangement is a joint operation.
Variation 1 – If, instead of A and B using their share of the output themselves, they sold their share of the
output to third parties, C would still be a joint operation.
Variation 2 – If A and B changed the terms of the contractual arrangement so that the arrangement was able
to sell output to third parties, this would result in C assuming demand, inventory and credit risks, such that A
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and B would not have substantially all of the economic benefits. Accordingly, in this case, the joint
arrangement would likely be a joint venture.
5.5
Illustrative examples accompanying IFRS 11
IFRS 11 provides several examples that illustrate aspects of IFRS 11, but are not intended to
provide interpretative guidance. The examples portray hypothetical situations illustrating
the judgements that might be used when applying IFRS 11 in different situations. Although
some aspects of the examples may be present in actual fact patterns, all facts and
circumstances of a particular fact pattern are evaluated when applying IFRS 11. [IFRS 11.IE1].
Example 12.15: Construction services7
A and B (the parties) are two companies whose businesses are the provision of many types of public and
private construction services. They set up a contractual arrangement to work together for the purpose of
fulfilling a contract with a government for the design and construction of a road between two cities. Th
e
contractual arrangement determines the participation shares of A and B and establishes joint control of the
arrangement, the subject matter of which is the delivery of the road.
The parties set up a separate vehicle (entity Z) through which to conduct the arrangement. Entity Z, on behalf
of A and B, enters into the contract with the government. In addition, the assets and liabilities relating to the
arrangement are held in entity Z. The main feature of entity Z’s legal form is that the parties, not entity Z,
have rights to the assets, and obligations for the liabilities, of the entity.
The contractual arrangement between A and B additionally establishes that:
(a) the rights to all the assets needed to undertake the activities of the arrangement are shared by the parties
based on their participation shares in the arrangement;
(b) the parties have several and joint responsibility for all operating and financial obligations relating to the
activities of the arrangement on the basis of their participation shares in the arrangement; and
(c) the profit or loss resulting from the activities of the arrangement is shared by A and B based on their
participation shares in the arrangement.
For the purposes of co-ordinating and overseeing the activities, A and B appoint an operator, who will be an
employee of one of the parties. After a specified time, the role of the operator will rotate to an employee of the other
party. A and B agree that the activities will be executed by the operator’s employees on a ‘no gain or loss’ basis.
In accordance with the terms specified in the contract with the government, entity Z invoices the construction
services to the government on behalf of the parties.
Analysis
The joint arrangement is carried out through a separate vehicle whose legal form does not confer separation
between the parties and the separate vehicle (i.e. the assets and liabilities held in entity Z are the parties’
assets and liabilities). This is reinforced by the terms agreed by the parties in their contractual arrangement,
which state that A and B have rights to the assets, and obligations for the liabilities, relating to the arrangement
that is conducted through entity Z.
The joint arrangement is a joint operation.
A and B each recognise in their financial statements their share of the assets (e.g. property, plant and
equipment, accounts receivable) and their share of any liabilities resulting from the arrangement (e.g.
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