Appendix B — Differences Between U.S. GAAP and IFRS Accounting Standards

Terminology

When an investor has an investment that is accounted for under the equity method (generally because the investor exercises significant influence over another entity), that entity is referred to as an investee.

When an investor has an investment in, and exercises significant influence over, an entity, that entity is referred to as an associate.

Scope: General

As described in Section 2.3, an investor must apply the equity method of accounting when it has significant influence over an investee unless (1) it has elected the fair value option or (2) it carries its investment at fair value under specialized industry accounting guidance applicable to investment companies. In these cases, the investor would record its interest at fair value. In addition, an investment in a partnership or certain LLCs requires the use of the equity method of accounting with as little as 3 percent to 5 percent ownership even if significant influence does not clearly exist.

An investor must apply the equity method of accounting when it has significant influence over an investee unless either of the following conditions applies:

• The investor is a venture capital organization, mutual fund, unit trust, or similar entity (including an investment-linked insurance fund) (collectively referred to as “investment entities”). For these entities, an investor may account for investments that would otherwise be accounted for under the equity method by using fair value through profit or loss (FVTPL) in accordance with IFRS 9.1 Further, if an investor holds a portion of its investment in an investee indirectly through investment entities, the investor may account for that portion of the investment at FVTPL. This election can be applied even in circumstances in which the direct investor does not have significant influence. If the investor makes this election, however, it still must apply the equity method of accounting to any portion of the investment not held through investment entities.
• The investor is exempt from preparing consolidated financial statements under paragraph 4(a) of IFRS 10 (i.e., certain parent-only and subsidiary financial statements). For further information, see A26.4.2 of Deloitte’s iGAAP publication.

Because IFRS Accounting Standards do not include a fair value option for equity method investments, the application of fair value rather than the equity method of accounting is more limited under IFRS Accounting Standards than it is under U.S. GAAP. For example, assume a manufacturing company reports under U.S. GAAP and has elected to apply the fair value option to its investments that would otherwise be accounted for in accordance with the equity method. In preparing IFRS financial statements, the company would be required to apply the equity method of accounting.

Scope: Investments in instruments other than common equity

As described in Section 2.5, an investor would apply the equity method of accounting for an investment in a corporation when it has significant influence over an investee and it holds an investment in common stock or in-substance common stock. In-substance common stock includes instruments that are substantially similar to common stock based on subordination, risks and rewards of ownership, and an obligation to transfer value.

In addition, there are unique rules under U.S. GAAP for a partnership and certain LLCs that maintain specific ownership accounts. These rules can result in application of the equity method of accounting with as little as 3 percent to 5 percent of the ownership interests in the investee.

The evaluation of significant influence is framed in reference to “voting power,” which can arise from instruments other than ordinary common shares. For example, when 50 percent of the voting rights in an entity are held by the ordinary shareholders and the other 50 percent of the voting rights are attached to voting preferred shares, an investment in 4 percent of the ordinary shares and 36 percent of the voting preferred shares will result in a presumption that the 4 percent ordinary share ownership will be accounted for under the equity method. Preferred shares would not be accounted for under the equity method unless they are substantively the same as ordinary shares. Factors that either individually or collectively may indicate that a preferred share investment is substantively the same as an ordinary share investment include:

• The investee has little or no significant ordinary shares or other equity, on a fair value basis, that is subordinate to the preferred shares.
• The investor, regardless of ownership percentage, has demonstrated the power to exercise significant influence over the investee’s operating and financial decisions. The power to participate actively is an important factor in the determination of whether an equity interest exists by virtue of preferred shareholdings.
• The investee’s preferred shares have essentially the same rights and characteristics as the investee’s ordinary shares in regard to voting rights, board representation, and participation in — or rate of return approximating — the ordinary share dividend.
• The preferred shares have a conversion feature (with significant value in relation to the total value of the shares) to convert the preferred shares to ordinary shares.

Therefore, while IFRS Accounting Standards do not specifically refer to “in-substance common stock,” the fact that significant influence is determined on the basis of “voting rights” results in similar application to investments in instruments other than common stock. For further information, see A26.3.3.4 and A26.4.4.3.3 of Deloitte’s iGAAP publication.

Applying the equity method of accounting: significant influence

As described in ASC 323-10-15-6 (see Section 3.3), significant influence “may be indicated in several ways, including the following:

1. Representation on the board of directors
2. Participation in policy-making processes
3. Material intra-entity transactions
4. Interchange of managerial personnel
5. Technological dependency
6. Extent of ownership by an investor in relation to the concentration of other shareholdings (but substantial or majority ownership of the voting stock of an investee by another investor does not necessarily preclude the ability to exercise significant influence by the investor).”

However, this list is not all-inclusive, and all relevant facts and circumstances should be considered.

Further, an investment of 20 percent or more in a corporation is presumed to provide significant influence. In addition, an investment greater than 3 percent to 5 percent in a partnership or LLC that maintains specific ownership accounts is generally considered an indication that the equity method of accounting should be applied.

IAS 28 provides considerations similar to those in U.S. GAAP for the evaluation of whether an investor holds significant influence over an investee:

1. “representation on the board of directors or equivalent governing body of the investee;
2. participation in policy-making processes, including participation in decisions about dividends or other distributions;
3. material transactions between the entity and its investee;
4. interchange of managerial personnel; or
5. provision of essential technical information.”2

This list is not all-inclusive, and all relevant facts and circumstances should be considered.

IFRS Accounting Standards also indicate that an investment representing 20 percent or more of the voting power of an entity is presumed to provide significant influence. However, IFRS Accounting Standards do not provide explicit thresholds for partnerships or LLCs. Nonetheless, the qualitative considerations regarding significant influence outlined above may yield the same accounting conclusion under IFRS Accounting Standards as would be reached under U.S. GAAP (i.e., an interest of much less than 20 percent may still yield significant influence in the context of a limited partnership). However, in other circumstances, the analysis may yield different conclusions under IFRS Accounting Standards. Each fact pattern must be analyzed separately.

For example, assume that a company owns a 10 percent limited partner interest in an investment partnership. The company does not have any participation in the investment partnership’s governance, investment decisions, or other significant activities and does not have any involvement with the investment partnership other than receiving distributions. Under U.S. GAAP, the company would apply the equity method of accounting to its interest in the investment partnership. But under IFRS Accounting Standards, the company might conclude that it does not have significant influence over the investment partnership.

For further information, see A26.3.2 and A26.3.4 of Deloitte’s iGAAP publication.

Applying the equity method of accounting: potential interests

As described in ASC 323-10-15-9 (see Section 3.2.6), an investor would consider only “present voting privileges.” Therefore, potential voting privileges are generally disregarded.

An investor should consider “potential voting rights that are currently exercisable or convertible.”3 Additional instruments contingent on future events or the passage of time would not be considered until the contingent event occurs or the specified time frame passes.

For example, an investor may conclude that although its present voting interest is less than 20 percent, it has significant influence as a result of “potential voting rights” it holds through a currently exercisable option agreement, which, when combined with the investor’s currently held ordinary shares, would provide the investor with more than 20 percent of the voting power. That is, it might be presumed that the investor has significant influence if the combination of its voting power from its investments in ordinary shares and the potential voting power from the currently exercisable option is at least 20 percent. Even though the option could provide the investor with significant influence, the option agreement itself is not accounted for under the equity method of accounting or considered in the investor’s measurement of equity earnings.

This concept also applies to warrants, options, or other instruments held by other investors. That is, an investor with greater than 20 percent of present voting interest may conclude that it does not have significant influence as a result of “potential voting rights” held by a third party through a currently exercisable option agreement if the exercise of the option would decrease the investor’s voting interest below 20 percent. This may lead to differences between U.S. GAAP and IFRS Accounting Standards regarding the existence of significant influence and thus the application of the equity method of accounting. Management’s intentions with respect to the exercise of the potential voting rights, the exercise price of such rights, and the financial capability of the holder to exercise them are ignored in the assessment of significant influence.

In another example, assume Investor A holds a 25 percent interest in Investee B. Investor C holds the remaining 75 percent in B. Investee B has also issued debt to C that is convertible at any time, at C’s option, to additional shares of B. If C elects to convert the debt, A’s ownership interest would be diluted to 10 percent. Under U.S. GAAP, A would be likely to conclude that it has significant influence over B since potential voting rights are disregarded. However, under IFRS Accounting Standards, A may conclude that it does not have significant influence over B because of the currently exercisable additional interests of C.

For further information, see A26.4.4.3.2 of Deloitte’s iGAAP publication.

Initial measurement: contingent consideration

As discussed in Section 4.4, contingent consideration may be recognized in two scenarios:

• When the contingent consideration meets the recognition criteria of U.S. GAAP (other than ASC 805), such as if the contingent consideration meets the definition of a derivative.
• When the noncontingent consideration offered is less than the interest in the investee’s underlying net assets.

While IFRS Accounting Standards do not provide explicit guidance, IAS 28 indicates that “the concepts underlying the procedures used in accounting for the acquisition of a subsidiary are also adopted in accounting for the acquisition of an investment in an associate.”4 Therefore, contingent consideration is generally recognized at its fair value on the acquisition date in accordance with IFRS 3. Subsequently, the liability is recognized at fair value with any changes in value recognized in the income statement. Therefore, any investment with contingent consideration may result in an initial cost basis that is greater under IFRS Accounting Standards than under U.S. GAAP.

For example, assume Investor A acquires a 25 percent interest in Investee B for $100 million in cash and contingent consideration due in one year (and based on the earnings of B) ranging from $5 million to $50 million. The share of net assets A acquired is $120 million, and the fair value of the contingent consideration is $25 million. In accordance with U.S. GAAP, A would recognize the cash consideration of $100 million and contingent consideration of $20 million (since the initial cost is less than the share of net assets acquired) for a total of $120 million. In accordance with IFRS Accounting Standards, A would recognize an initial cost of $125 million since the contingent consideration would be recognized at fair value under IFRS 3.

For further information, see A26.4.4.9 of Deloitte’s iGAAP publication.

Initial measurement: nonmonetary contributions, such as contributions of assets that meet the definition of a business and contributions of nonfinancial assets or in-substance nonfinancial assets

As described in Section 4.3.2, the contribution of assets that meet the definition of a business to an equity method investee should be accounted for in accordance with ASC 810, which requires full gain or loss recognition (unless the transaction is the conveyance of oil and gas mineral rights or a transfer of a good or service in a contract with a customer within the scope of ASC 606). As described in Section 4.3.4, a contribution of nonfinancial assets or in-substance nonfinancial assets that is not an output of the entity’s ordinary business activities (i.e., outside the scope of ASC 606) would generally be accounted for in accordance with ASC 610-20, which indicates that full gain or loss recognition is appropriate when the transaction meets the various recognition criteria described therein.

IFRS Accounting Standards contain conflicting guidance, which the IASB attempted to resolve through a narrow scope amendment. IAS 28 indicates that nonmonetary contributions should be recognized with partial gain recognition. This, however, conflicts with IFRS 10, which indicates that upon loss of control of a subsidiary, a parent should recognize full gain or loss. Therefore, when an entity contributes shares of a subsidiary in exchange for an equity method investment, the entity in effect has an accounting policy choice between applying the approach in IFRS 10 (“full gain recognition”) or IAS 28 (partial gain recognition) since both IAS 28 and IFRS 10 have equal standing under IFRS Accounting Standards.

The IASB issued Sale or Contribution of Assets Between an Investor and Its Associate or Joint Venture (Amendments to IFRS 10 and IAS 28) in September 2014 to resolve this conflict. The amendments would require an investor to determine whether the assets contributed represented a business. If they did, IFRS 10 would apply, and full gain recognition would be appropriate. If they did not, IAS 28 would apply, and partial gain recognition would be appropriate. However, the effective date of the amendments has been deferred indefinitely because several practical implementation issues were identified. The amendments will be considered as part of the IASB’s larger research project on the equity method of accounting. Therefore, until further guidance is issued, entities may continue to make an accounting policy choice between partial gain recognition and full gain recognition when applying IFRS Accounting Standards, whereas U.S. GAAP provides more specific requirements on the basis of whether the assets contributed constitute a business.

For further information, see A26.4.4.15 of Deloitte’s iGAAP publication.

Initial measurement: acquisition-date excess of investor’s share

The excess of (1) the investor’s share of the fair value of the investee’s identifiable assets and liabilities over (2) the carrying value of the identifiable assets and liabilities on the acquisition date is included as part of the basis difference and is amortized, if appropriate, over the useful life of the investee’s asset. The residual excess of the cost of the investment over the proportional fair value of the investee’s assets and liabilities is recognized within the equity investment balance as equity method goodwill, which is not amortized.

The excess of (1) the investor’s share of the net fair value of the associates’ identifiable assets and liabilities over (2) the cost of the investment as of the acquisition date is recognized as income in the period in which the investment is acquired.

Subsequent measurement: step acquisitions

As described in Section 5.6.2, when an additional interest in an entity is acquired that results in a change in the accounting for the investment to the equity method, the investor should apply the equity method of accounting on a prospective basis from the date it obtains significant influence over the investee.

IFRS Accounting Standards do not provide explicit guidance regarding the transition to the equity method of accounting. We believe that two approaches are acceptable. First, by analogy to business combination guidance (IFRS 3), a transaction resulting in significant influence could be viewed as a disposal of an existing interest and the acquisition of an interest that conveys significant influence. Second, the fair value of the existing interest may be considered the “deemed cost” of that portion of the interest on the date significant influence is obtained. Regardless of the approach used, the equity method of accounting would be applied only from the date significant influence was obtained forward. Thus, the entity would be required under both U.S. GAAP and IFRS Accounting Standards to apply the equity method prospectively. However, differences may continue to exist regarding the determination of the initial basis in the equity method investee and the recognition of any related gain or loss.

For further information, see A26.4.4.8 of Deloitte’s iGAAP publication.

Subsequent measurement: losses that exceed interests

As described in Section 5.2, an investor generally discontinues use of the equity method of accounting when the value of an investment reaches zero unless the investor has guaranteed obligations of the investee or is otherwise committed to provide further financial support to the investee. However, an investor should continue to recognize additional losses if the imminent return to profitable operations appears to be assured.

IFRS Accounting Standards typically require an investor to discontinue use of the equity method of accounting when the value of an investment reaches zero unless the investor has incurred legal or constructive obligations or made payments on behalf of the associate. However, unlike the requirements under U.S. GAAP, those under IFRS Accounting Standards do not permit an investor to continue to provide for additional losses if an imminent return to profitable operations by an associate appears to be assured.

For example, assume Investor A has a 25 percent interest in Investee B. Investor A’s carrying value is $50 million, and its share of B’s losses for the current year is $75 million. Investee B has recently refocused its product line and has sufficient sales contracts for the following year to ensure profitability. In accordance with U.S. GAAP, A would reduce its investment balance to zero and record a liability for $25 million, representing the excess of its share of losses over the existing carrying value. In accordance with IFRS Accounting Standards, A would reduce its investment balance to zero but would not record any further losses or liability.

For further information, see A26.4.4.16 of Deloitte’s iGAAP publication.

Subsequent measurement: impairment

As described in Section 5.5, an investor must determine whether its equity method investment has a loss in value and, if so, whether that loss is other than temporary. If an impairment is determined to be appropriate, investments with other-than-temporary losses must be written down to fair value. Impairment losses cannot be reversed in subsequent periods.

An investor first looks for any indicators of impairment as described in either (1) paragraphs 58 through 62 of IAS 39 (before the adoption of IFRS 9) or (2) paragraphs 41A through 41C of IAS 28 (after the adoption of IFRS 9). Under both standards, the impairment indicators focus on identifiable loss events that will affect future cash flows. Loss events can arise only from past events. If an impairment indicator exists, the investor must then measure any impairment as described in IAS 28. Impairments are measured in accordance with IAS 36 as the excess of the investment’s carrying value over its recoverable amount. The recoverable amount is calculated as the higher of the investment’s (1) fair value less cost to sell or (2) value in use. The investor can calculate the value in use by using either (1) the present value of the investor’s share of estimated future cash flows from the associate’s operations, including proceeds from the investment’s disposal, or (2) the present value of the investor’s estimated future dividends from the associate and estimated proceeds from the investment’s disposal. Under IAS 28, the investor should reverse previously recorded impairment losses to the extent that the recoverable amount of the investment subsequently increases. However, the investment can be written up no higher than its original cost basis.

Since IFRS Accounting Standards do not contemplate the concept of other-than-temporary losses but do allow reversals of impairments and use different measurement methods than do U.S. GAAP, significant differences may arise between IFRS Accounting Standards and U.S. GAAP when an entity is accounting for impairments of equity method investments.

For further information, see A26.4.4.19 and A26.4.4.20 of Deloitte’s iGAAP publication.

Subsequent measurement: investee accounting policies

As described in Section 5.1.3.3, an investor is not required to conform an investee’s accounting policies to its own as long as the investee’s accounting policies are an acceptable alternative under U.S. GAAP. The investor may elect to conform the investee’s accounting policies to its own when applying the equity method of accounting.

IFRS Accounting Standards specifically require an investor to conform an investee’s accounting policies to its own when applying the equity method of accounting.5 This may result in differences in accounting for equity method investments between U.S. GAAP and IFRS Accounting Standards.

For further information, see A26.4.4.13 of Deloitte’s iGAAP publication.

Subsequent measurement: investee fiscal year-end

As described in Section 5.1.4, an investor must record equity earnings or losses on the basis of the investee’s “most recent available financial statements.” It is usually acceptable for the investor to apply the equity method of accounting by using the equity method investee’s financial statements with a different reporting date as long as the reporting dates of the investor and investee are no greater than three months apart. In addition, the difference between the investor’s and investee’s reporting dates should be consistent in each reporting period. Finally, the investor is generally not required to record its share of the investee’s significant transactions or events occurring during the lag period. However, recognition should be given by disclosure or otherwise for intervening events that materially affect the investor’s financial position or results of operations.

The investor’s and investee’s reporting dates must be the same unless it is impracticable for them to be the same. When it is impracticable, the dates must be no more than three months apart, and the lag period should be consistent. In addition, as of the investor’s reporting date, the investor must record its share of the associate’s significant transactions or events that have occurred during the lag period. Therefore, differences may arise between U.S. GAAP and IFRS Accounting Standards, because IFRS Accounting Standards require recognition if such intervening transactions are significant, whereas U.S. GAAP do not.

For further information, see A26.4.4.12 of Deloitte’s iGAAP publication.

Subsequent measurement: loss of significant influence

As discussed in Section 5.6.5, when an investor loses significant influence over an investee, it recognizes any retained investment on the basis of historical cost and thus recognizes no gain or loss solely because of the loss of significant influence (and thus the discontinuance of the equity method of accounting). Note, however, that other U.S. GAAP (e.g., ASC 321) subsequently applicable to the investment may require measurement at fair value with changes in fair value recognized in income.

In accordance with ASC 321, an investor must remeasure the retained investment in accordance with ASC 321-10-35-1 or ASC 321-10-35-2, as applicable. In the application of ASC 321-10-35-2 to the investor’s retained investment, if the investor identifies observable price changes in orderly transactions for the identical or a similar investment of the same issuer that results in the investor’s discontinuance of the equity method, the entity must remeasure its retained investment at fair value immediately after discontinuing the equity method.

An investor would recognize any retained interest at fair value, with any difference between the fair value of the retained interest and the carrying value of the equity method investment recognized in the income statement. As a result, under IFRS Accounting Standards, an entity will recognize a gain or loss as a result of losing significant influence, whereas under U.S. GAAP, the entity will record the interest at fair value or by applying the measurement alternative. Note, however, that depending on the classification of the retained interest (e.g., any equity security that is measured at fair value), changes in fair value may be immediately recognized under other U.S. GAAP. In those instances, the impact to the income statement of losing significant influence may be the same under U.S. GAAP and IFRS Accounting Standards.

For further information, see A26.4.4.17 of Deloitte’s iGAAP publication.

Presentation: general and impairment

As discussed in Section 6.1, an equity method investment is presented as a single line item on the balance sheet and in the income statement. In addition, basis differences and investor-level impairments are typically recognized in the same line in the income statement as the equity in the investee’s earnings or losses.

An equity method investment is presented as a separate line item on the balance sheet and in the income statement. However, we generally believe that under IFRS Accounting Standards, investor-level impairments should not be offset against the share of profit or loss from an associate because this would conflict with the requirement to show that share of profit or loss as a separate line item. Therefore, differences may arise between IFRS Accounting Standards and U.S. GAAP regarding the classification of investor-level impairment charges in the income statement.

For further information, see A26.7.1 of Deloitte’s iGAAP publication.

Presentation: proportionate consolidation

As discussed in Section 2.4.3, under U.S. GAAP, proportionate consolidation may be used to account for undivided interests in assets and liabilities as well as investments in unincorporated legal entities, such as partnerships, in certain industries (i.e., construction and extractive).

The use of proportionate consolidation is technically not prescribed under IFRS Accounting Standards. However, for a joint operation, an investor would recognize its share of assets, liabilities, revenues, and expenses instead of applying the equity method of accounting. A joint operation is defined in Appendix A of IFRS 11 as 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.”

Presentation: held-for-sale classification

As described in Section 6.2.2.2, an equity method investment that does not qualify for discontinued operations reporting would not qualify for held-for-sale classification. An equity method investment that does qualify for discontinued operations would qualify for held-for-sale classification. However, equity method investments are not within the scope of the measurement guidance in ASC 360; rather, they must be assessed for impairment in accordance with ASC 323 even while classified as held for sale. In addition, ASC 323 does not provide specific guidance on disposals. Therefore, an investor should apply the equity method of accounting until the date on which significant influence is lost, which will usually not be before the date of disposal.

An equity method investment may be eligible for held-for-sale accounting if it satisfies certain criteria in paragraphs 6 through 12 of IFRS 5, including:

• The investment will be sold in a sale transaction.
• The investment is available for immediate sale.
• The sale is highly probable.
• The sale is expected to take place within one year.

If the held-for-sale criteria are met, an investor should record the equity method investment at the lower of its (1) fair value less cost to sell or (2) carrying value on the date when the held-for-sale criteria are met. The investor would no longer apply the equity method of accounting and would instead remeasure the held-for-sale investment as of each subsequent reporting date. In addition, the investment may qualify for separate presentation in the investor’s discontinued operations if it qualifies as a component of the entity and meets certain other criteria under paragraphs 31 and 32 of IFRS 5. Therefore, differences may arise between IFRS Accounting Standards and U.S. GAAP related to when the equity method of accounting will no longer apply and the measurement of the held-for-sale equity method investment.

Disclosures

As described in Chapter 6, an investor’s disclosure of its equity method investments should include the following:

• The investee’s name.
• The investor’s percentage ownership of the investee’s common stock.
• Basis differences.
• The aggregate value of that investment based on the quoted market price, if available.
• Summarized information regarding the assets, liabilities, and results of operations of investees, either individually or in the aggregate, for material investments.
• The factors leading to an accounting conclusion that either (1) a 20 percent or greater interest does not provide significant influence or (2) a less than 20 percent interest does provide significant influence.
• Information regarding material impacts of any potential conversion of outstanding convertible securities, exercise of outstanding options and warrants, and other contingent issuances on the investor’s share of reported earnings or losses.

Under IFRS 12, an investor must disclose information largely similar to that required to be disclosed under U.S. GAAP (excluding the required disclosure under U.S. GAAP for possible conversions of convertible securities and exercise of options and warrants). In addition, an investor must disclose:

• The investee’s principal place of business.
• The reporting dates of investments recorded on a lag and the reasons the dates are different.
• Any restrictions on the associate to pay dividends or repay loans to the investor.
• The investor’s share of the associate’s contingent liabilities.
• The unrecognized share of losses if the equity method of accounting has been suspended.

In addition, the summarized financial information must be provided separately for each material investment (whereas U.S. GAAP indicates the information should be provided individually or in the aggregate as appropriate). IFRS 12 also provides more prescriptive guidance regarding what specific information should be disclosed, including:

• Current assets.
• Noncurrent assets.
• Current liabilities.
• Noncurrent liabilities.
• Revenue.
• Profit or loss from continuing operations.
• Post-tax profit or loss from discontinued operations.
• OCI.
• Total comprehensive income.

Therefore, IFRS Accounting Standards require additional disclosures beyond those required under U.S. GAAP.

Definition, scope, and type of joint venture

As discussed in Section 7.2, in accordance with the definition of a joint venture in ASC 323-10-20, a joint venture has all of the following characteristics:

• It is a separate legal entity.
• It is owned by a small group of entities.
• The operations are for the mutual benefit of the venturers.
• The purpose is to “share risks and rewards in developing a new market, product or technology; to combine complementary technological knowledge; or to pool resources in developing production or other facilities.”
• Each venturer can participate, directly or indirectly, in the overall management. The members have an interest or relationship other than passive investors.
• It is not a subsidiary of one of the members.

ASC 323 addresses only separate legal entities. Other types of arrangements, such as collaborative arrangements, are addressed in other guidance.

A joint arrangement is an arrangement in which two or more parties have joint control.

IFRS 11 requires an investor to follow the three-step process below when classifying a joint arrangement as either a joint operation (controlled by joint operators) or a joint venture (controlled by joint venturers).

• Step 1 — If the joint arrangement is not structured through a legal vehicle, it should always be classified as a joint operation.
• Step 2 — If the parties have rights to the assets and obligations for the liabilities either through legal form of the entity or by contract (i.e., the assets and liabilities held in the separate vehicle are the assets and liabilities of the parties), the joint arrangement should be classified as a joint operation. Conversely, if the parties have rights to the net assets of the arrangement, step 3 should be considered.
• Step 3 — Despite the parties’ having only rights to the net assets of the arrangement, if the parties have designed the arrangement in such a way that (1) its activities provide the parties with the output (i.e., the parties receive substantially all of the economic benefit of the assets in the vehicle) and (2) the vehicle relies on the parties for settling the liabilities, the arrangement is a joint operation. Otherwise, the arrangement is a joint venture.

Accounting for jointly controlled entities

Generally, the venturer should apply the equity method of accounting, except in certain industries (i.e., the construction and extractive industries), in which proportionate consolidation is permitted.

A joint venturer should recognize its interest in a joint venture as an investment and should account for that investment by using the equity method in accordance with IAS 28 unless the venturer is exempted from applying the equity method as specified in that standard.

Accounting for jointly controlled operations

ASC 323 does not address jointly controlled operations (since a jointly controlled operation does not have a legal entity). However, ASC 808-10 addresses the accounting for collaborative arrangements, which are jointly controlled operations that are not primarily conducted through a legal entity. To be within the scope of ASC 808-10, a participant must be (1) an active participant in the joint operations conducted primarily outside of a legal entity and (2) exposed to significant risks and rewards that depend on the joint activity’s success. As in IFRS 11, under ASC 808-10, a participant recognizes costs incurred and revenue generated from transactions with third parties (i.e., nonparticipants) in its income statement. However, ASC 808-10 also requires a participant to record such amounts on a gross or net basis in its income statement in accordance with ASC 606-10-55-36 through 55-40. That is, a participant would record the amounts gross if it was the principal on the sales transaction with the third party or net if it was an agent to the transaction with the third party.

IFRS 11 specifies that 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. Those parties are called joint operators.” A joint operator recognizes the following attributes “in relation to its interest in a joint operation:

• 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 of the joint operation;
• its share of the revenue from the sale of the output by the joint operation; and
• its expenses, including its share of any expenses incurred jointly.”

Initial contribution of nonmonetary assets that meet the definition of a business to a joint venture or joint operation

A gain or loss is recognized as the difference between the following:

• The sum of the fair value of any consideration received, the fair value of any retained noncontrolling investment in the net assets as of the date of contribution (the date control is lost), and the carrying amount of any noncontrolling interest in the net assets as of the date of contribution (the date control is lost).
• The carrying amount of the net assets contributed as of the date of contribution (the date control is lost).

An accounting policy election among the following three approaches may be taken (unless a venturer adopted the amendments proposed by the IASB in September 2014 before it indefinitely deferred them in December 2015):

• Approach A (based on the September 2014 amendments to IFRS 10 and IAS 28) — In a transaction involving a joint venture, the extent of gain or loss recognition by the venturer depends on whether the assets sold or contributed constitute a business.
  When an entity (1) sells or contributes assets that constitute a business to a joint venture or (2) loses control of a subsidiary that contains a business but retains joint control, the gain or loss resulting from that transaction is recognized in full.
• Approach B (based on the guidance in IAS 28 before the adoption of the September 2014 amendments) — Paragraph 28 of IAS 28 states that any gain or loss is recognized by the venturer “only to the extent of unrelated investors’ interests in the . . . joint venture.”
• Approach C (based on the guidance in IFRS 10 before the adoption of the September 2014 amendments) — Under IFRS 10, the venturer derecognizes all the net assets of the former subsidiary and recognizes at fair value any consideration received and any retained interest in the former subsidiary.

Note that entities that cannot formally adopt the September 2014 amendments (e.g., because of a requirement for endorsement of changes to IFRS Accounting Standards in their jurisdiction) may adopt an accounting policy consistent with those amendments (i.e., distinguishing between transactions on the basis of whether the subsidiary being sold or contributed constitutes a business) provided that the requirements of paragraph 14(b) of IAS 8 are met (i.e., the change in policy results in the financial statements’ providing reliable and more relevant information). However, such a “voluntary” change in policy would have to be applied retrospectively in accordance with IAS 8; the transition provisions of the September 2014 amendments (which allow for prospective application to transactions occurring after a specified date) would not be available.

Initial contribution of nonmonetary assets that do not meet the definition of a business to a joint venture or joint operation

As discussed in Section 4.3.4, generally, venturers recognize the initial contributions of nonmonetary assets that do not meet the definition of a business at fair value and may recognize a gain if applicable.

An accounting policy election among the following three approaches may be taken (unless a venturer adopted the amendments proposed by the IASB in September 2014 before it indefinitely deferred them in December 2015):

• Approach A (based on the September 2014 amendments to IFRS 10 and IAS 28) — In a transaction involving a joint venture, when the venturer (1) sells or contributes assets that do not constitute a business to a joint venture or (2) loses control of a subsidiary that does not contain a business but retains joint control in a transaction involving a joint venture, the gain or loss resulting from that transaction is recognized only to the extent of the unrelated investors’ interests in the joint venture (i.e., the entity’s share of the gain or loss is eliminated). A new example added to IFRS 10 (see Appendix B, Example 17) illustrates the appropriate accounting in such circumstances.
• Approach B (based on the guidance in IAS 28 before the adoption of the September 2014 amendments) — Paragraph 28 of IAS 28 states that a gain or loss is recognized by the venturer “only to the extent of unrelated investors’ interests in the . . . joint venture.”
• Approach C (based on the guidance in IFRS 10 before the adoption of the September 2014 amendments) — Under IFRS 10 the venturer derecognizes all the net assets of the former subsidiary and recognizes at fair value any consideration received and any retained interest in the former subsidiary.

Note that entities that cannot formally adopt the September 2014 amendments (e.g., because of a requirement for endorsement of changes to IFRS Accounting Standards in their jurisdiction) may adopt an accounting policy consistent with those amendments (i.e., distinguishing between transactions on the basis of whether the subsidiary being sold or contributed constitutes a business) provided that the requirements of paragraph 14(b) of IAS 8 are met (i.e., the change in policy results in the financial statements’ providing reliable and more relevant information). However, such a “voluntary” change in policy would have to be applied retrospectively in accordance with IAS 8; the transition provisions of the September 2014 amendments (which allow for prospective application to transactions occurring after a specified date) would not be available.