IFRScommunity.com

Two parties agree a new joint operation, so each control their own assets and incur own costs, but agree a share of earnings.

At inception, one party pays the other an up front cash amount to incentivise the deal and to help them cover their initial operational costs. It's not repayable, not a loan, however the contributing party will receive preferential repayment of earnings until that initial payment is recouped.

I just want to gather thoughts on the treatment of that initial cash payment. As a joint operation it's not equity accounted at cost. The payment has all the hallmarks of an investment in something, (exposure to variable returns, no contractual cash flows etc) - but there is nothing to have an 'investment' in? There is no separate vehicle.

What are views on the substance of that investment? I can't see anything in IFRS 11 or examples.

It seems to be 'investment in joint venture' which would be easy to present but doesn't seem correct technically.

The trouble with it sitting there as an investment is that it can never be removed apart from impairment, because there is no entity to sell. Which moves me on to an intangible asset to be amortised over the expected life. It does seem to fit the definition of an intangible but now it feels like getting a long way from JV accounting!

Any thoughts gratefully received.

I suppose in substance it is the second party borrowing funds, secured/repayable only against future cash flows from their share of the joint operation, to the extent they arise.

I suppose in substance it is the second party borrowing funds, secured/repayable only against future cash flows from their share of the joint operation, to the extent they arise.

totally agree

so a loan that does not pass the SPPI test, therefore classified at FVTPL?

thanks, that sounds sensible. But does it meet the definition of a financial asset? The relevant definition would be:

"A contractual right to receive cash...from another entity".

There's no contractual right to receive anything, although I suppose the great share of earnings could be considered that.

Secondly, it's not from another entity, it's from it's own joint operation?

It does sound like contractual right to receive cash, though contingent upon future profits of JV

You can say that the substance is that it will come from the other venturer who will pass through some of its profits from JV until the loan is repaid (even if bank transfers will go directly from JV's account)

Yes I think it would be arguing from substance, because the JV agreement is varied so it's never actually the other party's share in the first place - it's just the variation has the effect of reducing the borrower's profit share initially. The fact that it is varied by reference to recouping the investment I suppose demonstrates that it is recoupment of that 'loan'.

I have been slowly thinking about this as the discussion has gone on. I went down a couple of rabbit holes related to IFRS 11.21 and various mining arrangements I have seen, but in the end I think they don't apply. I agree with where you ended up, this feels like a loan outside of the joint arrangement, from Operator A to Operator B. It just happens that the repayment is a contractual agreement to hand over profits from the joint operation.

thanks for your feedback exIFRS!
@JRSB - it seems you can proceed with this approach without looking back

oops! I accidentally deleted JRSB's last post... I'm sorry!

Just picking up if I may on the conclusion that we have a loan here, the question of the fair value arises.

In the absence of any meaningful comparable data, we could say that the total receivable is $1m (let's say the loan made) and so that may come as $200,000 a year for 5 years, but not contractually and with risk of earlier or later payments (or none at all). So the present value of those expected flows, adjusted for the risk of the project overall, would perhaps approximate a Level 3 fair value.

or would the better approach still be looking at corporate traded debt products for the size of discount required in as similar circumstances as close as possible? It feels both are very imperfect - but the latter being preferred as a Level 2?

One of the most significant inputs in this valuation relates to projected earnings of joint operation, therefore I don't see a way for this exercise to become a level 2 valuation...

I suppose that must be true, and perhaps specific project and country risk are the biggest factors. Thanks.

Picking up this case if I may.

Suppose the loan was €500,000. As established, recorded at fair value.

1 month later the project generates revenues and repays a contractually-determined €550,000. (Having established not being SPPI).

So initial recogniton at FV. But this doesnt equal transaction price since FV is higher than the amount loaned, given the circumstances.

What to do? It may come back again (as per now I think 2 other scenarios) a deferral of the initial gain until the loan is realised, then record in P&L?

Thanks

So you had day 1 gain, right?
there's a short summary here:
https://ifrscommunity.com/knowledge-bas ... ins-losses
I guess it's OK to recognise the deferred amount in P/L as the proceeds exceed the amount originally lent

I'm not clear on what the numbers mean in your example. 500k was the loan made, right, and fair value was higher? And now the repayment is 550k, so basically the loan was fully repaid after one month? Also, all income generated by the project is allocated to repayment of the loan first, and only then as a return on equity?

That's pretty much it.

(Why do people enter such transactions.. )

to keep accountants busy

IFRS 9 should not be so silent on the matter. The amortisation of the gain would put you at:

Day 1

Cr Bank €500,000
Dr Receivable at FV €550,000
Cr Deferred gain €50,000

Day 15 (etc)

Dr Deferred gain €25,000
Cr P&L -release of day 1 gain on FV of assets €25,000

Day 30

Dr Bank €550,000
Cr Receivable €550,000

yep, looks good,

plus there will be FV changes after day 1...

I personally like to keep things simple. Why not treat it simply as an advance and treat the receipt of excess as settlement of this advance.

On second thought my idea doesn't make sense. You should continue with the approach you are currently using.

I agree with keeping in simple, which I guess in this case would have been to charge a simple interest rate on the loan, have a fixed repayment date, and find some other mechanism to get the return ie JO earnings share.