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Structuring joint venture interests

MOHAN R. LAVI | Updated on: May 24, 2011

India has to amend existing standards on consolidation, joint ventures and investments in associates.

International Financial Reporting Standards (IFRS) minimised the if-not-x-then-y accounting possibilities that existed in many national accounting standards by providing for limited exceptions. Most of the exceptions are provided for in IFRS-1 on First time Adoption of IFRS.

IAS 31(Indian Accounting Standards 31) on Joint Ventures provided two possible methods of accounting for joint ventures - the equity method or the proportionate consolidation method though the standard subtly suggested the former.

The International Accounting Standards Board (IASB) recently has issued four new accounting standards - IFRS 10, 11, 12 and 13. IFRS 11 seeks to remove the option given to account for interest in joint ventures using the proportionate consolidation method, thereby restoring parity with IAS 28 on investments in associates.

Equity/Proportionate Consolidation

Under proportionate consolidation, the balance sheet of the venturer includes its share of the assets that it controls jointly and its share of the liabilities for which it is jointly responsible. The income statement includes its share of the income and expenses of the jointly controlled entity. IAS 31 allows for two different reporting formats for presenting proportionate consolidation - the venture may combine its share of each of the assets, liabilities, income and expenses of the jointly controlled entity with the similar items, line by line, in its financial statements or the venturer may include separate line items for its share of the assets, liabilities, income and expenses of the jointly controlled entity in its financial statements. Under the equity method of accounting, an equity investment is initially recorded at cost and is subsequently adjusted to reflect the investor's share of the net profit or loss of the joint venture. A number of multinationals have already voiced their protests over the move to force equity accounting on joint venture interests. Proportionate consolidation boosts a company's reported sales by recognising joint venture contributions higher up the income statement than would be the case under equity accounting. It also adds to assets and liabilities. However, there should be no difference in profit under the two approaches. The mining, oil, gas and real estate sectors use joint ventures the most and hence would be affected by the revised standard that is applicable from 2013 though the two-year time-frame gives them enough time to structure joint ventures.

IAS 27

One of the strong points of IFRS was IAS 27 on Consolidated and Separate Financial statements mandated consolidating subsidiaries over which an entity had control. Control being an intangible activity, IAS 27 provided four situations when one could be deemed to be in control - the mathematically ascertainable 50 per cent of voting power, power to appoint or remove majority of the members of the board and the power to cast majority of the votes or power to govern the operating and financial policies of the entity which could only be seen when exercised. This led to situations of entities having less than 50 per cent controlling an entity and entities with more than 50 per cent not in control of an entity.

Indian Accounting Standards recognised the possibility of more than one person being in control. The freshly-minted IFRS-10 attempts to solve the issue by categorically emphasising that even if the mathematical control test fails, the ultimate test of control would be the power of the entity to direct the activities of another entity with a view to generating returns - a definition that like most IFRS's relies on judgement. IFRS 12 - Disclosure of Interests in Other Entities is a new and comprehensive standard on disclosure requirements for all forms of interests in other entities, including joint arrangements, associates, special purpose vehicles and other off balance sheet vehicles.

IFRS 13

One of the areas where the IASB permitted US GAAP to take the limelight was in Fair Value Measurements. SFAS 157 and its new avatar after the Codification project of US GAAP - Topic 820 - defined fair value to be the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date and established a three-level hierarchy to ascertain Fair Value.

If Ind-AS is to match IFRS, the Institute of Chartered Accountants of India (ICAI) has to work on a standard for fair value and amend existing standards on consolidation, joint ventures and investments in associates and the Ministry of Corporate Affairs (MCA) would have to announce a fresh road-map for Ind-AS including the standards on financial instruments.

Further delay would only widen the gap between Ind-AS and IFRS.

(The author is a Bangalore-based chartered accountant.)

Published on May 19, 2011
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