accounts payable to third parties) on the basis of their agreed participation share.
Each also recognises its share of the revenue and expenses resulting from the construction services provided
to the government through entity Z.
Example 12.16: Shopping centre operated jointly 8
Two real estate companies (the parties) set up a separate vehicle (entity X) for the purpose of acquiring and
operating a shopping centre. The contractual arrangement between the parties establishes joint control of the
activities that are conducted in entity X. The main feature of entity X’s legal form is that the entity, not the
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parties, has rights to the assets, and obligations for the liabilities, relating to the arrangement. These activities
include the rental of the retail units, managing the car park, maintaining the centre and its equipment, such as
lifts, and building the reputation and customer base for the centre as a whole.
The terms of the contractual arrangement are such that:
(a) entity X owns the shopping centre. The contractual arrangement does not specify that the parties have
rights to the shopping centre;
(b) the parties are not liable in respect of the debts, liabilities or obligations of entity X. If entity X is unable
to pay any of its debts or other liabilities or to discharge its obligations to third parties, the liability of
each party to any third party will be limited to the unpaid amount of that party’s capital contribution;
(c) the parties have the right to sell or pledge their interests in entity X; and
(d) each party receives a share of the income from operating the shopping centre (which is the rental income
net of the operating costs) in accordance with its interest in entity X.
Analysis
The joint arrangement is carried out through a separate vehicle whose legal form causes the separate vehicle
to be considered in its own right (i.e. the assets and liabilities held in the separate vehicle are the assets and
liabilities of the separate vehicle and not the assets and liabilities of the parties). In addition, the terms of the
contractual arrangement do not specify that the parties have rights to the assets, or obligations for the
liabilities, relating to the arrangement. Instead, the terms of the contractual arrangement establish that the
parties have rights to the net assets of entity X.
Based on the description above, there are no other facts and circumstances that indicate that the parties have
rights to substantially all the economic benefits of the assets relating to the arrangement, and that the parties
have an obligation for the liabilities relating to the arrangement.
The joint arrangement is a joint venture.
The parties recognise their rights to the net assets of entity X as investments and account for them using the
equity method.
Example 12.17: Joint manufacturing and distribution of a product 9
Companies A and B (the parties) have set up a strategic and operating agreement (the framework agreement)
in which they have agreed the terms according to which they will conduct the manufacturing and distribution
of a product (product P) in different markets.
The parties have agreed to conduct manufacturing and distribution activities by establishing joint
arrangements, as described below:
(a) Manufacturing activity: the parties have agreed to undertake the manufacturing activity through a
joint arrangement (the manufacturing arrangement). The manufacturing arrangement is structured
in a separate vehicle (entity M) whose legal form causes it to be considered in its own right (i.e.
the assets and liabilities held in entity M are the assets and liabilities of entity M and not the assets
and liabilities of the parties). In accordance with the framework agreement, the parties have
committed themselves to purchasing the whole production of product P manufactured by the
manufacturing arrangement in accordance with their ownership interests in entity M. The parties
subsequently sell product P to another arrangement, jointly controlled by the two parties
themselves, that has been established exclusively for the distribution of product P as described
below. Neither the framework agreement nor the contractual arrangement between A and B dealing
with the manufacturing activity specifies that the parties have rights to the assets, and obligations
for the liabilities, relating to the manufacturing activity.
(b) Distribution activity: the parties have agreed to undertake the distribution activity through a joint
arrangement (the distribution arrangement). The parties have structured the distribution arrangement in
a separate vehicle (entity D) whose legal form causes it to be considered in its own right (i.e. the assets
and liabilities held in entity D are the assets and liabilities of entity D and not the assets and liabilities of
the parties). In accordance with the framework agreement, the distribution arrangement orders its
requirements for product P from the parties according to the needs of the different markets where the
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distribution arrangement sells the product. Neither the framework agreement nor the contractual
arrangement between A and B dealing with the distribution activity specifies that the parties have rights
to the assets, and obligations for the liabilities, relating to the distribution activity.
In addition, the framework agreement establishes:
(a) that the manufacturing arrangement will produce product P to meet the requirements for product P that
the distribution arrangement places on the parties;
(b) the commercial terms relating to the sale of product P by the manufacturing arrangement to the parties.
The manufacturing arrangement will sell product P to the parties at a price agreed by A and B that covers
all production costs incurred. Subsequently, the parties sell the product to the distribution arrangement
at a price agreed by A and B; and
(c) that any cash shortages that the manufacturing arrangement may incur will be financed by the parties in
accordance with their ownership interests in entity M.
Analysis
The framework agreement sets up the terms under which parties A and B conduct the manufacturing and
distribution of product P. These activities are undertaken through joint arrangements whose purpose is either
the manufacturing or the distribution of product P.
The parties carry out the manufacturing arrangement through entity M whose legal form confers
separation between the parties and the entity. In addition, neither the framework agreement nor the
contractual arrangement dealing with the manufacturing activity specifies that the parties have rights to
the assets, and obligations for the liabilities, relating to the manufacturing activity. However, when
considering the following facts and circumstances the parties have concluded that the manufacturing
arrangement is a joint operation:
(a) The parties have committed themselves to purchasing the whole production of product P manufactured
by the manufacturing arrangement. Consequently, A and B have rights to substantially all the economic
benefits of the assets of the manufacturing arrangement.
(b) The manufacturing arrangement manufactures product P to meet the quantity and quality needs of the
parties so that they can fulfil the demand for product P of the distribution a
rrangement. The exclusive
dependence of the manufacturing arrangement upon the parties for the generation of cash flows and the
parties’ commitments to provide funds when the manufacturing arrangement incurs any cash shortages
indicate that the parties have an obligation for the liabilities of the manufacturing arrangement, because
those liabilities will be settled through the parties’ purchases of product P or by the parties’ direct
provision of funds.
The parties carry out the distribution activities through entity D, whose legal form confers separation between
the parties and the entity. In addition, neither the framework agreement nor the contractual arrangement
dealing with the distribution activity specifies that the parties have rights to the assets, and obligations for the
liabilities, relating to the distribution activity.
There are no other facts and circumstances that indicate that the parties have rights to substantially all the
economic benefits of the assets relating to the distribution arrangement or that the parties have an obligation
for the liabilities relating to that arrangement.
The distribution arrangement is a joint venture.
A and B each recognise in their financial statements their share of the assets (e.g. property, plant and equipment,
cash) and their share of any liabilities resulting from the manufacturing arrangement (e.g. accounts payable to
third parties) on the basis of their ownership interest in entity M. Each party also recognises its share of the
expenses resulting from the manufacture of product P incurred by the manufacturing arrangement and its share
of the revenues relating to the sales of product P to the distribution arrangement.
The parties recognise their rights to the net assets of the distribution arrangement as investments and account
for them using the equity method.
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Variation
Assume that the parties agree that the manufacturing arrangement described above is responsible not only for
manufacturing product P, but also for its distribution to third-party customers.
The parties also agree to set up a distribution arrangement, as the one described above, to distribute product
P exclusively to assist in widening the distribution of product P in additional specific markets.
The manufacturing arrangement also sells product P directly to the distribution arrangement. No fixed
proportion of the production of the manufacturing arrangement is committed to be purchased by, or to be
reserved to, the distribution arrangement.
Analysis
The variation has affected neither the legal form of the separate vehicle in which the manufacturing activity is
conducted nor the contractual terms relating to the parties’ rights to the assets, and obligations for the liabilities,
relating to the manufacturing activity. However, it causes the manufacturing arrangement to be a self-financed
arrangement because it is able to undertake trade on its own behalf, distributing product P to third-party
customers and, consequently, assuming demand, inventory and credit risks. Even though the manufacturing
arrangement might also sell product P to the distribution arrangement, in this scenario the manufacturing
arrangement is not dependent on the parties to be able to carry out its activities on a continuous basis.
In this case, the manufacturing arrangement is a joint venture.
The variation has no effect on the classification of the distribution arrangement as a joint venture.
The parties recognise their rights to the net assets of the manufacturing arrangement and their rights to the
net assets of the distribution arrangement as investments and account for them using the equity method.
Example 12.18: Bank operated jointly10
Banks A and B (the parties) agreed to combine their corporate, investment banking, asset management and services
activities by establishing a separate vehicle (bank C). Both parties expect the arrangement to benefit them in
different ways. Bank A believes that the arrangement could enable it to achieve its strategic plans to increase its
size, offering an opportunity to exploit its full potential for organic growth through an enlarged offering of products
and services. Bank B expects the arrangement to reinforce its offering in financial savings and market products.
The main feature of bank C’s legal form is that it causes the separate vehicle to be considered in its own right
(i.e. the assets and liabilities held in the separate vehicle are the assets and liabilities of the separate vehicle
and not the assets and liabilities of the parties). Banks A and B each have a 40 per cent ownership interest in
bank C, with the remaining 20 per cent being listed and widely held. The shareholders’ agreement between
bank A and bank B establishes joint control of the activities of bank C. In addition, bank A and bank B entered
into an irrevocable agreement under which, even in the event of a dispute, both banks agree to provide the
necessary funds in equal amount and, if required, jointly and severally, to ensure that bank C complies with
the applicable legislation and banking regulations, and honours any commitments made to the banking
authorities. This commitment represents the assumption by each party of 50 per cent of any funds needed to
ensure that bank C complies with legislation and banking regulations.
Analysis
The joint arrangement is carried out through a separate vehicle whose legal form confers separation between
the parties and the separate vehicle. The terms of the contractual arrangement do not specify that the parties
have rights to the assets, or obligations for the liabilities, of bank C, but it establishes that the parties have
rights to the net assets of bank C. The commitment by the parties to provide support if bank C is not able to
comply with the applicable legislation and banking regulations is not by itself a determinant that the parties
have an obligation for the liabilities of bank C. There are no other facts and circumstances that indicate that
the parties have rights to substantially all the economic benefits of the assets of bank C and that the parties
have an obligation for the liabilities of bank C.
The joint arrangement is a joint venture.
Both banks A and B recognise their rights to the net assets of bank C as investments and account for them
using the equity method.
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Example 12.19: Oil and gas exploration, development and production activities11
Companies A and B (the parties) set up a separate vehicle (entity H) and a Joint Operating Agreement (JOA)
to undertake oil and gas exploration, development and production activities in country O. The main feature
of entity H’s legal form is that it causes the separate vehicle to be considered in its own right (i.e. the assets
and liabilities held in the separate vehicle are the assets and liabilities of the separate vehicle and not the
assets and liabilities of the parties).
Country O has granted entity H permits for the oil and gas exploration, development and production activities
to be undertaken in a specific assigned block of land (fields).
The shareholders’ agreement and JOA agreed by the parties establish their rights and obligations relating to
those activities. The main terms of those agreements are summarised below.
Shareholders’ agreement
The board of entity H consists of a director from e
ach party. Each party has a 50 per cent shareholding in
entity H. The unanimous consent of the directors is required for any resolution to be passed.
Joint Operating Agreement (JOA)
The JOA establishes an Operating Committee. This Committee consists of one representative from each party.
Each party has a 50 per cent participating interest in the Operating Committee.
The Operating Committee approves the budgets and work programmes relating to the activities, which also
require the unanimous consent of the representatives of each party. One of the parties is appointed as operator
and is responsible for managing and conducting the approved work programmes.
The JOA specifies that the rights and obligations arising from the exploration, development and production
activities shall be shared among the parties in proportion to each party’s shareholding in entity H. In
particular, the JOA establishes that the parties share:
(a) the rights and the obligations arising from the exploration and development permits granted to entity H
(e.g. the permits, rehabilitation liabilities, any royalties and taxes payable);
(b) the production obtained; and
(c) all costs associated with all work programmes.
The costs incurred in relation to all the work programmes are covered by cash calls on the parties. If either
party fails to satisfy its monetary obligations, the other is required to contribute to entity H the amount in
default. The amount in default is regarded as a debt owed by the defaulting party to the other party.
Analysis
The parties carry out the joint arrangement through a separate vehicle whose legal form confers separation
between the parties and the separate vehicle. The parties reversed 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 JOA that entitle them to rights to the assets (e.g. exploration and
development permits, production, and any other assets arising from the activities) and obligations for the
liabilities (e.g. all costs and obligations arising from the work programmes) that are held in entity H.
The joint arrangement is a joint operation.
Both company A and company B recognise in their financial statements their own share of the assets and of any
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 169
