What is a Joint Arrangement?

Most business professionals would agree that understanding joint arrangements can be confusing.

This article clearly defines key terminology, explains how to classify joint arrangements, and provides real-world examples to help demystify joint arrangements.

You'll learn the difference between joint operations and joint ventures, how each arrangement impacts accounting and reporting, as well as solutions for common joint arrangement challenges.

Introduction to Joint Arrangements

A joint arrangement is an agreement between two or more parties to share control over an economic activity, as defined under IFRS 11 Joint Arrangements. There are two types of joint arrangements - joint operations and joint ventures.

Defining Key Terms: Joint Arrangements and IFRS 11

A joint arrangement exists when two or more parties have joint control. Joint control means contractually agreed sharing of control of an arrangement, with decisions about relevant activities requiring unanimous consent of the parties sharing control.

IFRS 11 classifies joint arrangements as either joint operations or joint ventures:

A joint operation exists when the parties have rights to the assets and obligations for the liabilities of the arrangement. Parties account for their share of assets, liabilities, revenues and expenses.
A joint venture exists when the parties have rights to only the net assets of the arrangement. Joint ventures are accounted for using the equity method under IAS 28 or at fair value under IFRS 9.

Types of Joint Arrangements: Operation vs Venture

The two types of joint arrangements have key differences:

Joint Operation:

Parties have direct rights to assets and obligations for liabilities
Parties recognize their share of assets, liabilities, revenues and expenses

Joint Venture:

Parties have rights only to net assets
Accounted for as investment using equity method or at fair value

Determining the type of joint arrangement depends on the legal form, contractual terms and other facts.

Accounting for Joint Operations: An Example Overview

If a joint arrangement is classified as a joint operation, parties account for their share of assets, liabilities, revenues and expenses, such as:

Recognize share of jointly held assets (e.g. inventory, property & equipment)
Recognize share of liabilities incurred (e.g. accounts payable, debt)
Recognize share of revenues from selling output
Recognize share of expenses incurred (e.g. depreciation, staff costs)

For example: Company A and B have a joint operation. A and B each have 50% share. If the joint operation has $100,000 of inventory, $50,000 of payables, $200,000 of revenue and $80,000 of expenses in a period - Company A would recognize $50,000 of inventory, $25,000 of payables, $100,000 of revenue and $40,000 of expenses.

Accounting for Joint Ventures Under IAS 28

If a joint arrangement is classified as a joint venture, parties account for it as an investment using the equity method under IAS 28 Investments in Associates and Joint Ventures or at fair value under IFRS 9 Financial Instruments.

Under the equity method, a party recognizes its initial investment at cost. The carrying amount is then increased or decreased to recognize the party's share of the joint venture's profits or losses after the acquisition date. IAS 28 sets out requirements for applying the equity method.

Alternatively, a party can elect to measure its investment at fair value through profit or loss under IFRS 9, recognizing changes in fair value in net income.

Transition and Guidance: Amendments to IFRS 10

IFRS 11 replaced IAS 31 Interests in Joint Ventures. When first adopting IFRS 11, an entity is required to reassess all its joint arrangements based on the new criteria for classification.

Amendments to IFRS 10 Consolidated Financial Statements provide transition relief by grandfathering previous assessments of control. This impacts whether a party consolidates a joint operation that is structured through a separate vehicle.

Disclosure requirements are set out in IFRS 12 Disclosure of Interests in Other Entities. Entities are required to provide information about the nature, risks and effects of interests in joint arrangements and associates.

What do you mean by joint arrangements?

A joint arrangement refers to an arrangement where two or more parties have joint control. Joint control exists only when decisions about the relevant activities of the arrangement require unanimous consent of the parties sharing control.

There are two types of joint arrangements under IFRS 11 Joint Arrangements:

Joint operations - where the parties that have joint control have rights to the assets and obligations for the liabilities relating to the arrangement.
Joint ventures - where the parties that have joint control have rights to the net assets of the arrangement.

Some key characteristics of joint arrangements:

Established by contracts
Two or more parties are bound by a contractual arrangement
Joint control exists only when decisions require unanimous consent

Parties to a joint arrangement recognize their respective share of assets, liabilities, revenues and expenses of the joint operation. Joint ventures are accounted for using the equity method as specified in IAS 28 Investments in Associates and Joint Ventures.

In summary, a joint arrangement provides joint control and unanimous decision making to the parties bound by the arrangement's contract. The specific accounting treatment depends on whether it is structured as a joint operation or joint venture.

How do you classify joint arrangements?

Joint arrangements are classified as either joint operations or joint ventures based on the rights and obligations of the parties involved.

In a joint operation, the parties that share joint control have rights to the assets and obligations for the liabilities relating to the arrangement. For example, two oil companies that jointly operate an oil rig would each recognize their share of the assets, liabilities, revenues and expenses from that operation.

In contrast, a joint venture involves the establishment of a separate entity over which the parties have joint control. The parties have rights to the net assets of the arrangement, but do not have direct rights to assets or obligations for liabilities. For example, two companies that jointly control and operate a retail store through a separate legal entity would each recognize their investment in that entity using the equity method of accounting.

The key difference lies in whether a separate vehicle is established. Joint operations do not establish a separate vehicle, while joint ventures do. Proper classification is essential, as it impacts the accounting treatment. Joint operations recognize their share of assets, liabilities, revenues and expenses directly, while joint ventures recognize an investment in the jointly controlled entity.

In summary:

Joint operations - No separate vehicle, direct rights to assets/liabilities
Joint ventures - Separate legal entity created, equity method accounting

Proper classification of joint arrangements requires analysis of the legal form and contractual terms between the parties sharing control. Getting this right is vital for accurate financial reporting.

What is an example of a joint operation?

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.

An example of a joint operation is a shared service center set up as a separate vehicle by two companies, Company A and Company B, each holding a 50% interest. The shared service center, Company C, provides accounting and administrative services to Companies A and B.

Company C would be classified as a joint operation under IFRS 11 Joint Arrangements because:

Companies A and B have joint control over Company C based on their equal 50% ownership and voting rights.
Company C's activities primarily provide services to Companies A and B. Its purpose is to serve their operating needs rather than to generate profits for itself.
Companies A and B have rights to the assets and obligations for the liabilities of Company C relating to the arrangement, by virtue of their ownership interests. For example, they would be entitled to a share of any equipment or property owned by C and be responsible for a share of C's costs and liabilities.

Therefore, Company C meets the criteria set out in IFRS 11 for classification as a joint operation. Companies A and B would recognize their share of assets, liabilities, revenues and expenses of C in their own financial statements.

What is accounted for in a joint arrangement?

A joint arrangement is an arrangement where two or more parties have joint control. Joint control exists only when decisions about relevant activities require unanimous consent of the parties sharing control.

There are two types of joint arrangements under IFRS 11:

Joint operations - where the parties that have joint control have rights to the assets and obligations for the liabilities relating to the arrangement.
Joint ventures - where the parties that have joint control have rights to the net assets of the arrangement.

In a joint operation, each joint operator recognizes in its financial statements:

Its assets, including its share of any assets held jointly
Its liabilities, including its share of any liabilities incurred jointly
Its revenue from the sale of its share of the output arising from the joint operation
Its expenses, including its share of any expenses incurred jointly

For example, Oil Company A and Oil Company B have a joint arrangement to operate an oil pipeline. The binding arrangement establishes that both companies have rights to the assets, and obligations for the liabilities, relating to the joint operation.

Company A would recognize in its financial statements:

Its share of the joint assets (e.g. 50% of the pipeline)
Its share of any joint liabilities
Its share of revenues from carrying oil through the pipeline
Its share of expenses related to operating the pipeline

In contrast, joint ventures only require recognizing the investment using the equity method as per IAS 28. Joint operations account for assets, liabilities, revenues and expenses directly.

Assessing Joint Control and Classification

Joint arrangements require the unanimous consent of the parties sharing control in order to make decisions about relevant activities. Determining if joint control exists is critical for classifying the arrangement and applying the appropriate accounting treatment under IFRS 11 Joint Arrangements.

Determining Joint Control: Examples and Scenarios

Joint control exists only when decisions about relevant activities require the unanimous consent of the parties sharing control. Some factors to consider when assessing joint control include:

Ownership percentage - No single party controls the arrangement solely through ownership percentage. Joint control typically exists when each party owns 50%.
Contractual agreements - The contractual terms explicitly state that unanimous consent is required from all parties sharing control for decisions over relevant activities.
Veto rights - Each party sharing control has veto rights over decisions, indicating joint control.

For example, Company A and Company B set up a separate entity where each owns 50% ownership interest. The entity's Articles of Incorporation state that at least 75% of voting rights are needed to make decisions over relevant activities. This indicates Company A and Company B share joint control.

Factors to Consider in Joint Control Assessment

There are certain nuances around some factors that can impact the joint control assessment:

If an arrangement includes veto rights, confirm whether those rights apply only to operational decisions or if they extend to strategic/relevant activities requiring unanimous consent between the parties sharing control.
When ownership percentages are not equal between the parties, assess if there are other contractual terms that require unanimous consent that establish joint control.
The level of involvement of each party in the arrangement's ongoing decision-making and relevant activities should align with the joint control assessment.

Classifying the Arrangement: Operation or Venture

Once joint control is determined to exist, the next step is assessing whether the arrangement is a joint operation or joint venture:

Joint operations - parties have direct rights and obligations to underlying assets/liabilities. Parties recognize their share of assets/liabilities/revenues/expenses.
Joint ventures - arrangement is structured through a separate vehicle where parties have rights only to the net assets. Joint ventures are equity accounted.

The structure through a separate vehicle alone does not necessarily mean it is a joint venture. An assessment of other rights and obligations under contractual arrangements is required to determine the appropriate classification.

Impact on Accounting and Financial Reporting

Properly assessing joint control and classifying the arrangement is crucial, as the accounting treatment differs significantly:

Joint operations - parties directly recognize their share of underlying assets, liabilities, revenues and expenses.
Joint ventures - equity method is applied. Parties recognize their share of the joint venture's net assets/profit or loss.

Misclassifying a joint arrangement can lead to inaccurate financial reporting. Performing a detailed joint control assessment and classification analysis is key to ensuring IFRS compliance.

Structure and Legal Forms of Joint Arrangements

Joint arrangements can take various legal forms depending on factors like taxation, governance needs, flexibility, and exit options. Here we'll outline common structures used for joint operations and joint ventures.

Common Structures for Joint Operations and Ventures

Some typical structures include:

Partnerships: General or limited partnerships allow two or more entities to share profits and control. No separate legal entity is created.
Corporations: A separate jointly-owned corporation can be created to house the joint arrangement.
Contractual agreements: Contracts like consortiums and collaborations allow looser joint arrangements without creating a separate entity.
Unincorporated associations: An organizational structure owned and controlled collectively by members without formal incorporation.

The structure impacts the accounting treatment - whether joint operations or joint ventures.

Key Considerations for Legal Structure Selection

Factors to consider when selecting a legal structure include:

Tax implications: Some structures offer more favorable tax treatment over others.
Governance: More complex ventures may need structures with clearer governance rules.
Flexibility: Can the structure accommodate changes in the arrangement or ownership stakes?
Exit options: How easily can a party exit the venture if needed?

The best structure balances control, risk, and flexibility for all parties involved.

Establishing a Separate Vehicle Joint Venture

Creating a separate legal entity for a joint venture simplifies accounting but requires:

Forming a new legal entity in the chosen structure.
Transferring assets, employees etc into the new entity.
Issuing ownership shares to participating entities.
Establishing governance rules and exit options.

Challenges include upfront costs, complex transfers, and aligning different shareholders.

Real-World Examples of Joint Arrangement Structures

A manufacturing JV between two competitors using a Limited Liability Corporation.
A consortium for a massive engineering project structured as an unincorporated association.
A joint shale gas extraction operation set up as a general partnership.

The legal structure profoundly impacts the economics and accounting of the joint arrangement.

Operational Management of Joint Arrangements

Governance Models for Joint Arrangements

There are a few common governance models that can be implemented for joint arrangements, depending on the number of partners and desired level of control:

Equal partnership - All partners have equal ownership and votes. Simple but can lead to deadlocks if there are disagreements. Best for arrangements with 2 partners.
Weighted partnership - Ownership percentages and votes are proportional to investment. Gives greater control to larger stakeholders.
Rotating leadership - Partners take turns leading the arrangement for set periods of time. Allows shared but shifting operational control.
Hierarchical structure - Larger partners have greater control and oversight, smaller partners operate more independently. Works for arrangements with many partners.

The key is finding the right balance of responsibility, control, and flexibility suitable for your specific partners and objectives. Formal agreements should outline governance processes including financial reporting, audits, dispute resolution, leadership appointments, etc.

Preventing & Resolving Joint Arrangement Disputes

To prevent disputes in joint arrangements:

Establish clear roles, responsibilities, ownership structures, and decision-making protocols upfront
Maintain open communication channels between all partners
Set measurable key performance indicators and monitor regularly
Schedule periodic strategic reviews to realign on objectives

If disputes do occur, first seek mediation through discussion and compromise. Alternatives like arbitration, buying out partners, or dissolving the arrangement can be costly.

Managing Changes and Transitions

To handle transitions in joint arrangements over time:

Allow flexibility in ownership structures - set processes for partners changing stakes
Outline procedures if a partner wants to exit the arrangement
Enable smooth leadership transitions with succession planning
Develop criteria and processes if new partners will be brought in

Update legal agreements and communicate changes across the partnership to facilitate adjustments while protecting current partners.

Monitoring Performance

Leading practices for monitoring joint operations:

Establish financial reporting procedures, formats, and timelines
Set KPIs based on strategic goals - track with business intelligence tools
Conduct periodic operational audits and reviews
Create joint dashboards showing high-level performance metrics
Automate reporting where possible - identify and investigate irregularities

Ongoing performance monitoring ensures you can course-correct issues early and capitalize on opportunities.

Dissolution & Disposal of Joint Arrangements

In this final section, we'll discuss dissolution and disposal considerations - outlining termination clauses, exit mechanisms, disposal procedures, and accounting treatment.

Triggers for Dissolution of Joint Arrangements

We'll start by identifying common triggers that can lead partners to dissolve a joint operation or joint venture, whether voluntarily or involuntarily:

Failure to meet business objectives or performance targets specified in the joint arrangement agreement
Irreconcilable differences or disputes between partners that cannot be resolved
Changes in strategic priorities causing partners to no longer be aligned on the joint arrangement's goals
Financial problems or bankruptcy of one or more partners
Regulatory changes or government interventions making the joint arrangement unviable

Any of these triggers can lead partners to exit a joint arrangement, either through mutual agreement or through built-in termination clauses.

Exit Mechanisms & Termination Clauses in Joint Arrangements

Next, we'll analyze the exit mechanisms and termination clauses typically built into joint arrangement contracts to facilitate the dissolution process when needed:

Buy/sell clauses - Allow one partner to propose a buyout price to acquire the other partner's interest, which they can choose to accept or counter
Shotgun clauses - Force a partner who triggers dissolution to either purchase the other partner's stake or sell its own stake at a set fair market value price
Deadlock provisions - Outline dissolution terms if partners reach an impasse and cannot make key business decisions
Change of control clauses - Allow partners to exit if one partner undergoes a change of ownership or control
Wind-up timeframes - Define periods for winding up the joint arrangement's operations and settling accounts upon dissolution

Building clear termination triggers and exit mechanisms into joint arrangement contracts provides clarity on the dissolution process if partners need to separate in the future due to irreconcilable differences or changing business priorities.

Disposal Procedures for Joint Ventures

We'll then explain recommended step-by-step procedures for divesting interest in or exiting a joint arrangement to ensure all legal, financial, operational, and accounting matters are handled appropriately:

Valuate interest - Obtain independent valuations to establish fair market value for the joint arrangement interest being divested
Find buyer - Seek potential buyers through business networks, brokers, or public sale processes in accordance with arrangement terms
Negotiate sale terms - Structure deal terms on pricing, timing, transition arrangements and get partner approvals if needed
Settle accounts - Settle any outstanding payments, charges, expenses owed between partners related to the joint arrangement
Unwind operations - Coordinate unwinding intertwined operations, assets, contracts, resources, etc. and transfer any allocated items
Execute legal documentation - Sign binding sale & purchase agreement and any other required legal agreements
Update financial reporting - Reflect disposal accounting treatment, deconsolidate financials, recognize gains/losses in reporting
Conclude wind-up matters - Finalize any administrative dissolution matters, file notifications, cancel licenses, etc.

Undertaking this structured exit process ensures interests are divested properly amidst the complexity of jointly operated businesses.

Impact on Financial Reporting During Disposal

Finally, we'll discuss the accounting treatment and impacts on financial reporting when disposing of an interest in a joint operation or joint venture:

For joint operations, any gains or losses from disposing of assets contributed or allocated to the operation are recognized immediately
For joint ventures, a gain or loss is recognized on the full carrying value of the investment when control or significant influence is lost
The investment asset must be derecognized, and is no longer accounted for under the equity method after the sale
If some retained interest remains, it may be recognized as a financial asset measured at fair value
Consolidated financial statements must deconsolidate and eliminate the former joint venture's accounts
Extensive disclosures are required detailing the circumstances of the joint arrangement dissolution

Following through on these accounting implications ensures the unwinding and disposal of the former joint arrangement interest is properly presented in financial statements during this transitional event.

Addressing Challenges and Solutions in Joint Arrangements

Identifying and Overcoming Joint Arrangement Problems

Joint arrangements can present several common challenges, including disagreements over control and decision-making, improperly structured agreements, uneven investment or profit sharing, and issues around exiting the arrangement.

To overcome these problems, it's important to clearly define responsibilities, rights, and procedures upfront in a joint arrangement agreement. Building in flexibility for evolving situations, addressing dispute resolution proactively, and fostering open communication channels between partners can also help avoid pitfalls. Regularly reviewing performance and renegotiating terms as needed keeps the arrangement on track.

Case Studies: Solutions to Complex Joint Arrangement Issues

Company A ran into problems several years into a joint operation when their partner wanted to increase investment but Company A lacked funds. By amending the original agreement's terms to allow additional external investors, Company A avoided dissolving a profitable operation.
Company B and their joint venture partner encountered cultural clashes around decision-making approaches. Establishing a protocol for constructive discussion and conflict resolution introduced more flexibility, enabling compromises.
Company C's joint venture partner went bankrupt. Having structured the original agreement to allow buying the partner's share, Company C could quickly take full control without disrupting ongoing operations.

Sale of Output by a Joint Operator: IFRS 11 Considerations

Under IFRS 11, a joint operator that sells output on behalf of the joint operation recognizes their share of revenue, expenses, assets and liabilities like any other party. Joint operations are not separate entities.

Specific accounting considerations around the sale of output include recognizing expenses in relation to obligations for unsold output, measurement principles for revenue and corresponding receivables, and any assets or liabilities related to output purchase arrangements.

Post-implementation Review of IFRS 10, IFRS 11, and IFRS 12

The post-implementation review found that by clarifying control principles, IFRS 10 and 11 have improved accounting for joint arrangements and the quality of disclosures. Some challenges remain around certain implementation issues and assessing joint control. IFRS 12 has enhanced transparency but disclosure overload is a concern. Work to address these issues continues.

Consolidation and Disclosure: IFRS 12 and Beyond

IFRS 12 specifies disclosure requirements for subsidiaries, joint arrangements, associates and structured entities. Topics covered include judgments made, risks posed, interests held, and reconciling financial statement amounts. Applying IFRS 12 ensures users understand an entity's interests in other entities. Further standards may continue improving consolidation and disclosure practices.

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