Subsequent accounting for contingent consideration

Chapter 35 – Joint Ventures Page 455 Recognition of these amounts should be included in the individual entity financial statements of each venturer because they are part of its activities. No further adjustment is therefore required in the preparation of the consolidated financial statements. [IAS 31.15] Illustration 2 An example of a jointly controlled operation is the construction of a new housing estate by a number of independent builders and specialist tradesmen, such as carpenters and plumbers. Each party provides a predetermined amount of labour to the construction and is required to provide the relevant materials and equipment needed to perform the work. Under an agreed contract, each party will receive a specified percentage of the revenue from the sale of the houses. This is an extension of each party’s normal operating activities and should therefore be recorded in their individual books and records as such.

4.2 Jointly controlled assets

A joint venture relationship may be established through the use of jointly controlled assets which are used to generate benefits to be shared by each of the venturers. Such arrangements do not involve the creation of a separate entity and the assets may be jointly owned, although the important attribute of such an arrangement is that the assets in question are jointly controlled. Typically each venturer receives an agreed share of the benefits generated by the operation of the assets and bears an agreed share of the expenses incurred. Each venturer in such an arrangement is again essentially using the assets as part of its normal operating activities and should therefore report them as part of those activities in its individual financial statements. In particular, a venturer should recognise its share of the jointly controlled assets, any liabilities that the entity has an obligation to meet and a share of the liabilities that are jointly incurred. Jointly incurred expenses and a share of the relevant income and expenses that are earned or incurred jointly should also be recognised by each venturer. [IAS 31.21] Illustration 3 A common use of jointly controlled assets is by entities in the oil production industry. Typically, they jointly control and operate an oil pipeline. The benefit of such an arrangement is that only one pipeline is needed, with each venturer using the pipeline to transport its own supply of oil and in return paying a proportion of the running costs of the pipeline i.e. the jointly controlled asset. No additional adjustments are required in the preparation of the consolidated financial statements since the individual entity financial statements of each venturer already reflect the economic reality of the arrangements.

4.3 Jointly controlled entities

The third broad type of joint venture arrangement is a jointly controlled entity. The identifying factor in this arrangement is that a separate legal entity is set up with ownership being shared by the venturers. The separate entity may take a number of forms. It may be an incorporated entity, a corporation or a partnership. The importance of the establishment of a separate entity is that it is able to enter into contracts and raise finance in its own right. As a separate legal entity it will also have to maintain its own accounting records and prepare and present its own financial statements. Chapter 35 – Joint Ventures Page 456 A jointly controlled entity controls its own assets, incurs its own expenses and liabilities and generates its own income. Each venturer will typically be entitled to a predetermined proportion of the profits made by the joint venture entity. Illustration 4 Joint venture entities are often set up to pool resources where operations are very similar in a separate line of business. Assets are combined and operated jointly from the joint venture entity. Such entities are particularly common in the telecommunications industry. Where a venturer has an interest in a jointly controlled entity, it is required to recognise in its consolidated financial statements its share of the entity either by proportionate consolidation or by equity accounting. Proportionate consolidation involves consolidating the venturer’s share of the individual line items of the joint venture’s financial statements, whereas equity accounting reports the change in the venturer’s share of the joint venture entity’s net assets each period. [IAS 31.30, 31.38]

4.3.1 Proportionate consolidation

Proportionate consolidation is where the venturer’s share of the joint venture’s assets, liabilities, income and expenditure is combined line by line with the venturer’s own items. [IAS 31.3] Proportionate consolidation uses the principles used in the full consolidation process required by IAS 27 for the reporting of subsidiaries. The different proportions that are consolidated in respect of a subsidiary and a joint venture represents the different levels of control held by the parent entity. In a subsidiary, the parent has ultimate control and therefore 100 of a subsidiary’s net assets and results are consolidated, whereas control is shared in a joint venture, so only the venturer’s share is consolidated. The venturer may present the effects of proportionate consolidation in one of two ways. The first is by combining the proportion of the joint venture results and financial position on a line by line basis with that of the venturer’s financial statements. This method results in single figures being presented for each line item. The alternative method is to split each line item between that which relates to the venturer and that which represents the proportion of the joint venture entity.

4.3.2 Equity method

As an alternative to proportionate consolidation, a joint venture entity may be accounted for by applying the equity method. The equity method of accounting is used to account for investments in associates under IAS 28 Investments in associates. It requires the initial investment to be recorded at cost and adjusted each period for the venturer’s share of the change in the net assets and results of the joint venture entity. [IAS 31.3] IAS 31 permits the use of the equity accounting method although it recommends the use of proportionate consolidation. A venturer should cease accounting for a joint venture entity under either method when it ceases to have joint control over the joint venture. If the venturer obtains complete control of the joint venture, then it should be accounted for in accordance with IAS 27 from that date. [IAS 31.36, 31.41, 31.45] On the date on which an entity ceases to have joint control over an entity, any retained interest in the investment should be measured at fair value. At this date, the investor should also recognise in profit or loss the difference between the carrying amount of the investment