IFRS 11 AND OIL AND GAS

JOINT ARRANGEMENTS
 Energy and Natural Resources | IFRS 11 and Oil and Gas Joint Arrangements

In May 2011, the International Accounting Standard

Board (IASB) issued IFRS 11 Joint Arrangements1, which
supersedes IAS 31 Interests in Joint Ventures and SIC 13
Jointly Controlled Entities – Non-Monetary Contributions
by Venturers. The standard is effective for years beginning
on or after January 1, 2013.

Since it is very common in the oil and gas industry for companies to enter
into joint arrangements, IFRS 11 could have a significant impact on all
The terminology
entities in this industry, from early stage exploration companies to large
fully integrated companies. The first change to be aware of is the introduction of the term joint
arrangement. A joint arrangement is an arrangement under which
The impact of IFRS 11 on oil and gas companies could be significant, as it could two or more parties have joint control. A joint arrangement has the
change the accounting for the joint arrangements these entities enter into: following characteristics:

For companies that have existing joint arrangements, there is a potential

• The parties are bound by a contractual arrangement
for the legal form which was agreed upon by the parties to conflict with • The contractual arrangement gives two or more of those parties
how it is accounted for after the transition to IFRS 11. Aside from the joint control of the arrangement
potential change to the accounting, the companies may discover that this
IFRS 11 classifies joint arrangements into two types:
transition could impact the business objectives of their joint arrangements.
For companies that are considering entering into joint arrangements, it is
• Joint operation: A joint operation is a joint arrangement whereby the
parties that have joint control of the arrangement (i.e. joint operators)
important to understand how some of the key requirements of IFRS 11 will
have rights to the assets, and obligations for the liabilities, relating to
impact how you structure your agreements to ensure it is accounted for
the arrangement
properly under the new standard.
• Joint venture: A joint venture is a joint arrangement whereby the
Overall approach parties that have joint control of the arrangement (i.e. joint venturers)
have rights to the net assets of the arrangement. Under IAS 31 the
FIRST ASSESSMENT

term joint venture was used to describe all joint arrangements, now it
JOINT CONTROL NO is used to describe a type of joint arrangement
Do all the parties, or Outside the scope
a group of the parties, In many cases, this terminology will often differ from the contractual terms.
of IFRS 11
have joint control over It will not be uncommon for two oil and gas companies to enter into “joint
the arrangement? venture agreement” to explore a property, which from an IFRS 11 standpoint
will be considered a joint operation.
YES
SECOND ASSESSMENT

JOINT ARRANGEMENT Joint operation

CLASSIFICATION
Analysis of the parties’
rights and obligations 1. The IFRS was published concurrently with four other standards: IFRS 10
arising from the Consolidated Financial Statements, IFRS 12 Disclosure of Interests in Other Entities,
arrangement Joint venture IAS 28 (as amended in 2011) Investments in Associates and Joint Ventures and IAS 27
(as amended in 2011) Separate Financial Statements.
Energy and Natural Resources | IFRS 11 and Oil and Gas Joint Arrangements

Joint control Example 1 – Voting rights

Joint control is the contractually agreed sharing of control of an Three parties establish an arrangement in which entities A, B and C
arrangement. It exists only when decisions about the relevant activities have 50, 30 and 20 per cent of the voting rights in the arrangement,
of the arrangement require the unanimous consent of the parties sharing respectively. The contractual arrangement specifies that at least
the control of the arrangement. For this purposes, “relevant activities” are 75 per cent of the voting rights are required to make decisions about the
defined in IFRS 10 as being activities of the arrangement that significantly relevant activities. Therefore, even though A can block any decision, it
affect its returns. does not control the arrangement because it needs the agreement of B.
An arrangement can be a joint arrangement even when not all of its parties The contractual terms mean that A and B have implicit joint control of
have joint control of the arrangement. IFRS 11 distinguishes between parties the arrangement because decisions about the relevant activities of the
that have joint control of a joint arrangement (joint operators and joint arrangement cannot be made without both A and B agreeing. However
venturers) and parties that participate in, but do not have joint control of, if the ownership percentages were 50, 25 and 25 joint control does not
a joint arrangement (those parties hold a simple investment). exist unless the contractual arrangement among the parties specified
which combination of them is required to agree about decisions in respect
Sometimes the decision-making process that is agreed upon by the parties of the relevant activities.
in their contractual arrangement implicitly leads to joint control. For example:
• Assume two parties establish an arrangement in which each has 50% Scenario 1 Scenario 2
of the voting rights Ownership Entity A – 50% Entity A – 50%
• The contractual arrangement between them specifies that at least 51% Entity B – 30% Entity B – 25%
of the voting rights are required to make decisions about the relevant Entity C – 20% Entity C – 25%
activities.
In this case, the parties have implicitly agreed that they have joint control
of the arrangement because decisions about the relevant activities cannot Decisions about At least 75% of the At least 75% of the
be made without both parties agreeing. relevant activities voting rights are voting rights are
required required
In other circumstances, the contractual arrangement might require a
minimum proportion of the voting rights to make decisions. When that
minimum required proportion of the voting rights can be achieved by more Is there joint YES - implicit joint NO - unless
than one combination of the parties agreeing together, that arrangement control? control contractually agreed
is not a joint arrangement unless the contractual arrangement specifies
which parties (or combination of parties) are required to agree unanimously
to decisions about the relevant activities of the arrangement. Example #1
illustrates this. It is very common for projects within the oil and gas industry to be
undertaken by a number of parties, with one party being designated as
the “Operator” who has the responsibility for running the project on a
day to day basis. Under current practice it is generally considered that
the Operator does not control the project, but that they are acting as an
agent for each of the parties. When transitioning to the new standard, it
will be very important, in some circumstances, to analyze the rights of
the Operator to determine whether joint control exists, or whether the
Operator is able to control the project without the agreement of any other
parties. If the Operator is acting as an agent, joint control is not precluded
and the arrangement should be evaluated under IFRS 11. If it is determined
that the operator is acting as a principal, i.e. that they have control, the
arrangement will need to be accounted for under other standards by each of
the parties. The factors that need to be reviewed to determine whether the
operator is a principle or agent are described in IFRS 10, and are as follows:
• Scope of the Operator’s decision-making authority (i.e. to what extent
can the operator make strategic decisions);
• Rights of the non-operators (to remove the Operator or to otherwise
protect their investment);
• Remuneration (is the remuneration for acting as the Operator dependent
on the services that they have provided or the success of the project?);
• Their exposure to variable returns from other interests in the project
(this may be applicable when they have provided financial guarantees in
respect of the project not provided by other parties).
 Energy and Natural Resources | IFRS 11 and Oil and Gas Joint Arrangements

Classification of joint arrangements as joint operations

or joint ventures
A joint arrangement
is an arrangement
The classification of a joint arrangement as a joint operation or a joint
venture depends upon the rights and obligations of the parties to the
arrangement.
When assessing the parties’ rights and obligations arising from the
arrangement, consider the following:
under which two
• The structure of the joint arrangement
• When the joint arrangement is structured through a separate vehicle:
or more parties have
–– the legal form of the separate vehicle
–– the terms of the contractual arrangement, and, when relevant,
joint control.
other facts and circumstances.

Structure of the joint arrangement The following is an example of how other factors could influence the
A joint arrangement that is not structured through a separate vehicle is a classification of joint arrangement structured through a separate vehicle:
joint operation. In such cases, the contractual arrangement establishes the
parties’ rights to the assets, and obligations for the liabilities, relating to
Example 2 – Joint arrangement structured through a
the arrangement, and the parties’ rights to the corresponding revenues and
obligations for the corresponding expenses.
separate vehicle
Assume that two parties structure a joint arrangement in an incorporated
The contractual arrangement often describes the nature of the activities
entity in which each party has a 50 per cent ownership interest. The
that are the subject of the arrangement and how the parties intend to
purpose of the arrangement is to mine and produce gold concentrate,
undertake those activities together. For example, the parties to a joint
that each would further refine at their own processing facilities.
arrangement could agree to develop a property, with each party being
responsible for specific tasks and each using its own assets and incurring The entity’s legal form initially indicates that the assets and liabilities
its own liabilities. In such a case, each joint operator recognizes in its held in the entity are the assets and liabilities of the entity. The
financial statements the assets and liabilities used for the specific task, and contractual arrangement between the parties does not specify that
recognizes its share of the revenues and expenses in accordance with the the parties have rights to the assets or obligations for the liabilities.
contractual arrangement. Accordingly, it appears that the arrangement is a joint venture. However,
the parties also consider the following aspects of the arrangement:
In other cases, the parties to a joint arrangement might agree to share and
operate an oil and gas well. In such a case, the contractual arrangement • Under the terms of the arrangement, the parties have agreed to
establishes the parties’ rights to the well that is operated jointly, and how purchase all of the product produced by the entity in a ratio of 50:50.
output or revenue from the asset and operating costs are shared among The entity cannot sell any of the output to third parties, unless this is
the parties. Each of the parties accounts for its share of the joint asset and approved by the two parties to the arrangement. The entity cannot
its agreed share of any liabilities, and recognizes its share of the output, sell any of the output to third parties, unless this is approved by the
revenues and expenses in accordance with the contractual arrangement. two parties to the arrangement.
This is the typical working interest arrangement used by upstream oil and
gas companies in Canada, and the resulting accounting will be similar to • The price of the output sold to the parties is set by both parties
that previously used. at a level that is designed to cover the costs of production and
administrative expenses incurred by the entity. On the basis of this
Joint arrangement structured through a separate vehicle operating model, the arrangement is intended to operate at a break-
even level.
A joint arrangement in which the assets and liabilities relating to the arrangement
are held in a separate vehicle can be either a joint venture or a joint operation. From the fact pattern above, it can be concluded that:
The legal form of the separate vehicle can be relevant when assessing the • The obligation of the parties to purchase all the output produced by
type of joint arrangement. For example, the parties might conduct the the entity reflects the exclusive dependence of the entity upon the
joint arrangement through a separate vehicle, whose legal form causes the parties for the generation of cash flows and, thus, the parties have an
separate vehicle to be considered in its own right (i.e. the assets and liabilities obligation to fund the settlement of the liabilities of the entity.
held in the separate vehicle are the assets and liabilities of the separate
• The fact that the parties have rights to all the output produced by the
vehicle and not the assets and liabilities of each of the parties to the joint
entity means that the parties have rights to all the economic benefits
arrangement). In such a case, the assessment of the rights and obligations
of the assets of the entity.
conferred upon the parties by the legal form of the separate vehicle indicates
that the arrangement is a joint venture. However, the terms agreed by the These facts and circumstances indicate that the arrangement is a
parties in their contractual arrangement and, when relevant, other facts and joint operation.
circumstances can override the assessment by the legal form of the separate
vehicle and result in it being accounted for as a joint operation.
Energy and Natural Resources | IFRS 11 and Oil and Gas Joint Arrangements

Structure of the joint arrangement

Structured through a separate vehicle Not structured through a separate vehicle

Legal Form
Does the legal form of the separate vehicle give the parties rights to the
assets and obligations for the liabilities relating to the arrangement?
NO YES

Terms of contractual arrangement

Do the terms of the contractual arrangement specify that the parties
have rights to the assets and obligations for the liabilities relating to the
arrangement?
NO YES

Other facts and circumstances

Have the parties designed the arrangement so that:
• its activities primarily aim to provide the parties with an output, and
• it depends on the parties on a continuous basis for settling the liabilities
relating to the activity conducted through it?

NO YES

JOINT VENTURE JOINT OPERATION

Accounting for joint arrangements

The classification of your joint arrangement will ultimately impact the
accounting. Joint ventures are required to be accounted for using the equity
method. For many entities in the oil and gas industry this will be a change,
as use of proportionate consolidation is the predominant industry practice
under IAS 31.
Joint operations shall recognize 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 arising from 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. For many entities the
accounting for joint operations will resemble proportionate consolidation
accounting under IAS 31.
 Energy and Natural Resources | IFRS 11 and Mining Joint Arrangements

The impact of IFRS 11

on oil and gas companies
could be significant,
as it could change the
accounting for the joint
arrangements these
entities enter into.

The transition An entity’s interest in the assets and liabilities relating to the joint
operation is determined on the basis of its rights and obligations in a
Joint ventures — transition from proportionate consolidation to the specified proportion in accordance with the contractual arrangement.
equity method The initial carrying amounts of the assets and liabilities are measured by
When changing from proportionate consolidation to the equity method, disaggregating them from the carrying amount of the investment at the
an entity recognizes its investment in the joint venture as at the beginning beginning of the earliest period presented.
of the earliest period presented. That initial investment is measured at Any difference arising from the investment previously accounted for using
the aggregate of the carrying amounts of the assets and liabilities that the equity method together with any other items that formed part of the
the entity had previously proportionately consolidated, including any entity’s net investment in the arrangement and the net amount of the
goodwill arising from acquisition. If the goodwill previously belonged to assets and liabilities, including any goodwill, recognized is accounted for
a larger cash-generating unit, or to a group of cash-generating units, the as follows:
goodwill is allocated to the joint venture on the basis of the relative carrying
amounts of the joint venture and the cash-generating unit or group of cash- • Offset against any goodwill relating to the investment with any
generating units to which it belonged. The opening aggregated balance of remaining difference adjusted against retained earnings at the beginning
the above investment is regarded as its deemed cost at initial recognition. of the earliest period presented, if the net amount of the assets
and liabilities, including any goodwill, recognised is higher than the
If aggregating all previously proportionately consolidated assets and investment (and any other items that formed part of the entity’s net
liabilities results in a net liability position, an entity assesses whether it investment) derecognized.
has legal or constructive obligations in relation to the net liabilities and,
if so, recognizes the corresponding liability. If it is concluded that there • Adjusted against retained earnings at the beginning of the earliest period
are no legal or constructive obligations in relation to the net liabilities the presented, if the net amount of the assets and liabilities, including any
corresponding liability is not recognised, with an adjustment being made to goodwill, recognized is lower than the investment (and any other items
retained earnings at the beginning of the earliest period presented. In such that formed part of the entity’s net investment) derecognized.
cases, disclosure is required that this approach has been followed, along with
a note of the cumulative unrecognised share of losses of joint ventures as at Plan for the impact of IFRS 11
the beginning of the earliest period presented and at the date at which IFRS
The impact of IFRS 11 on companies in the oil and gas industry could be
11 is first applied.
significant, as it could change the accounting for the joint arrangements
Joint operations — transition from the equity method to accounting these entities enter into. In some cases, there is a potential for the legal
form which was agreed upon by the parties to conflict with how it is
for assets and liabilities
accounted for after the transition to IFRS 11. Aside from the potential
When changing from the equity method to accounting for assets and change to the accounting, the companies may discover that this transition
liabilities in respect of its interest in a joint operation, an entity is required, could impact the business objectives of their joint arrangements.
at the beginning of the earliest period presented, to derecognise the
investment that was previously accounted for using the equity method, Although the standard is not effective until 2013, the transitional provisions
and any other items that formed part of the entity’s net investment in the require restatement of the comparative periods, which for entities with
arrangement and recognise its share of each of the assets and the liabilities calendar year ends means considering all arrangements as of January 1, 2012.
in respect of its interest in the joint operation, including any goodwill that We highly recommend beginning the process by reviewing the original
might have formed part of the carrying amount of the investment. agreements of your joint arrangements as soon as possible.
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