IMPACT ON OIL AND GAS COMPANIES

September 2011

Changes to joint venture accounting

The financial statements of many oil and gas companies could look very different in the future
as a result of the changes to the accounting for joint arrangements (formerly joint ventures).This
could affect key performance measures and ratios for companies in the sector, which raises the
question of how such changes should be communicated to investors and other stakeholders.
Assessing the effect of the new requirements for your company may take significant time and
judgement.The number and variety of joint arrangements in the oil and gas sector means that
planning for transition in advance of the 1January 2013 effective date is of particular importance.
Key questions that you should consider asking yourself
Question

Considerations

I proportionately
consolidate jointly
controlled entities what
will the changes mean for
my financial statements?

The option to proportionately consolidate has been eliminated. Assuming there is no change
to the classification of arrangements, a change from proportionate consolidation to equity
accounting will affect virtually all financial statement line items, notably decreasing revenue,
gross assets and gross liabilities. If the joint venture has tax expense, then transition will also
decrease profit before tax. See page 3.

I equity account my jointly

controlled entities does
this mean there will be no
significant change?

The change to the definitions of different types of arrangements may mean that some jointly
controlled entities will be accounted for on a line-by-line basis under the newstandard.

What determines the

classification of joint
arrangements under the
new standard?

In summary, arrangements in which you have joint control and individual rights/obligations to the
underlying individual assets and liabilities will be accounted for on a line-by-line basis. When the
rights are to net assets, equity accounting will apply. However, the process for assessing these
rights follows a series of tests, and analysis of the detail of the legal and contractual arrangements
as well as the substance of the arrangements will be required. This will require judgement and
could well be time-consuming if you have a number of arrangements. See page 5.

In this case, individual balances in the financial statements will change. For example, the
operating profit of the arrangement will form part of your total operating profit. See page 3.

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How do the new rules for accounting

for joint arrangements differ from
current requirements?
IFRS 11 Joint Arrangements was issued to replace IAS 31
Interests in Joint Ventures. As well as changes to terminology,
the new standard brings some potentially significant
accounting changes.
Put simply, IFRS 11 does two things.
First, it changes the classification of IAS 31 jointly
controlled entities if separation between the arrangement
and the party is deemed ineffective. These arrangements
are treated similarly to jointly controlled assets/operations
under IAS 31 and are now called joint operations.
Second, the free choice of using the equity method or
proportionate consolidation to account for the remainder of
IAS 31 jointly controlled entities, now called joint ventures,

is eliminated; joint venturers must now always use the

equity method.
The remainder of this document discusses what these
changes could mean for the financial statements and
processes of oil and gas companies. It also highlights the
main areas of judgement to be considered.
The most time-consuming part of planning for transition will
be reviewing arrangements to determine the classification
for accounting purposes. This will involve judgement and
the consideration of more factors than under current
requirements.
IFRS 11 sub-categorises arrangements into:
joint operations, whereby the parties with joint control
have rights to the assets, and obligations for the liabilities,
relating to the arrangement; and
joint ventures, whereby the parties with joint control have
rights to the net assets of the arrangement.

The differences between the joint arrangement classification and accounting models of the existing IAS31 and the new IFRS11
can be illustrated as follows:

Key
JCO/JCA: Jointly controlled operation/jointly controlled asset
JCE: Jointly controlled entity

JO: Joint operation

JV: Joint venture

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Impact 1: No more proportionate

consolidation
Under IAS 31 there was an accounting policy
choice available to account for interests
in jointly controlled entities using either
proportionate consolidation or the equity
method. IFRS11 removes the option to apply
proportionate consolidation and requires
equity accounting for joint ventures.
The IASBs view is that proportionate consolidation is not
appropriate in the absence of rights/obligations directly to/for
the separate assets/obligations of the arrangement.
Some companies felt there was little substantive difference
between their jointly controlled entities and other joint
arrangements and appreciated being able to account for these
in a similar way. IFRS11 removes this option.
The elimination of proportionate consolidation is expected to
significantly affect a number of companies in the oil and gas
sector. In KPMGs 2008 publication Application of IFRS: Oil
and Gas proportionate consolidation was found to be applied
by just under half of the companies included in the survey
who had jointly controlled entities.
The equity accounting requirement relates to joint ventures
under the IFRS 11 definition. The term joint venture is a widely
used operational term in the oil and gas sector that can
refer to a variety of risk-sharing arrangements that will not
necessarily meet the IFRS 11 definition.

Effects to be considered on transition from

proportionate consolidation to equity
accounting
Changes to the presentation of financial statements
There is a potentially significant effect on the presentation
of key line items in the financial statements and on
important performance measures. For example, revenue
and assets and liabilities will decrease, and operating result
will change if the result of joint ventures will be shown
outside of operating profit.

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There also may be other consequential effects resulting

from the cessation of proportionate consolidation. For
example, a venturers interest expense may no longer be
capitalised into a joint ventures assets. Similarly, when a
venturer has hedged a joint ventures assets or liabilities
(e.g. hedge accounting interest rate risk of a joint ventures
debt), there is no case for hedge accounting once equity
accounting is applied.
Communication
The effect of changes to the financial statements on
debt and remuneration agreements and performance
measures should be assessed. When this is expected to be
significant, you will need to consider the timing and form
of communications with lenders, shareholders, analysts,
employees and other stakeholders.
In some cases, you may wish to consider re-negotiating
existing contracts to take into account the effect of
transition.
Systems
Depending on whether equity accounting already was
applied in preparing the financial statements, consolidation
systems may need to be updated to reflect the new
accounting approach.

Impact 2: Changes to definitions will

affect accounting and require analysis
Under IFRS 11, joint arrangements are
essentially defined in the same way as under
IAS 31: an arrangement over which there is
joint control. What is new is the way in which
IFRS11 sub-categorises joint arrangements.
Oil and gas companies commonly use joint arrangements
to share risks and costs, for example sharing the costs of
exploring and developing a field, or jointly running a terminal.
The form of arrangements varies considerably and therefore
assessment of the appropriate accounting requires careful
consideration and judgement.

Joint control
The first step will be to consider recent changes to the
definition of control. Joint control exists when there is a
contractual agreement that decisions about the relevant
activities require the unanimous consent of the parties. The
need for a contract to confer joint control is not new. However,
the definition of control has changed as a result of IFRS10
Consolidated Financial Statements, which is applicable from
the same date as IFRS11.
Under IFRS 10 an investor has control when it is exposed, or
has rights, to variable returns from its involvement with that
investee and has the ability to affect those returns through
its power over the investee. The new control model requires
identification of how decisions affecting relevant activities
are made. These relevant activities typically exclude decisions
that apply only in exceptional circumstances, such as
onliquidation.
Details of arrangements need to be assessed to determine if
these new definitions change the list of joint arrangements for
accounting purposes.
There are often a number of different agreements that may
influence this assessment, including terms of reference,
joint operating agreements and even agreements with
operators. An operator of an oil field, for example, may
determine day-to-day decisions about the arrangement, but
that will not necessarily mean that the operator has control.
In fact, in many cases the operator is clearly subject to key
strategic decisions made by the partners. As a result, being
the operator alone will not determine control in many cases;
however, the specific nature of the agreements in place
should be assessed.

Classification of joint arrangements

There are two classifications for joint arrangements under
IFRS 11: joint operations and joint ventures. The definition of
each classification differs from that of IAS 31. The structure of
the joint arrangement is no longer the sole factor determining
the accounting.
The new classifications may result in an accounting result
similar to proportionate consolidation for some arrangements
previously accounted for as jointly controlled entities. There
are specific tests to be applied in making this determination.
These tests are designed to take a more substance-based
approach to classification and they may introduce additional
judgement into theprocess.

Effects to be considered on transition to the

new classifications of joint arrangements
Changes to the presentation of financial statements
The effect on the financial statements will depend on the
specific arrangements in place.
Arrangements that are not structured through a separate
vehicle (such as a company) will be joint operations.
Therefore, arrangements currently classified as jointly
controlled assets or jointly controlled operations will be
joint operations under IFRS 11 and the accounting for these
will not change significantly.
Arrangements structured through a separate vehicle may
be joint operations or joint ventures depending on the
terms and circumstances of the arrangement.
The accounting for joint operations is similar to that
currently applied for jointly controlled assets and jointly
controlled operations: recognition of the assets and
liabilities controlled and recognition of income generated
and expenses incurred in relation to the companys share in
the joint operation.
Changing classification from jointly controlled entity to joint
operation will therefore affect the financial statements
when those arrangements were previously equity
accounted.
Communication
The effect of changes to financial statements on debt and
remuneration arrangements and performance measures
will need to be assessed. When this is expected to be
significant, you will need to consider the timing and form
of communications with lenders, shareholders, analysts,
employees and other stakeholders.
Systems
Transition to IFRS 11 will require an assessment of all joint
arrangements, and may require experienced staff.
Depending on the changes in classification that arise under
the new standard, accounting systems may need to be
updated for changes in approach.

The process to be followed to determine the classification of

arrangements is discussed on page 5.

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How to determine the classification

of joint arrangements
The considerations for determining the
form of a joint arrangement have changed.
Changes to classification may significantly
affect the accounting treatment.

In practice, the number and variety of joint arrangements in

the oil and gas sector means that there may be more entities
that qualify as joint operations than in other industries,
although this will depend on the circumstances of each
arrangement.

Structure
The structure of the arrangement is the first factor to be
considered in assessing the type of arrangement, but it is not

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There are two classifications for joint arrangements under

IFRS 11:
In a joint operation, each jointly controlling party has rights
to the separate assets or obligations for the liabilities
relating to the arrangement
In a joint venture, each jointly controlling party has rights to
the net assets of an arrangement.
The classification process is summarised in the following
flowchart.

the sole determining factor. If an arrangement is structured

through a separate vehicle (such as a company), then the
arrangement could be a joint operation or a joint venture,
depending on the rights and obligations.
If an arrangement is not structured through a separate vehicle,
then the arrangement will be a joint operation. As a result,
arrangements currently classified as jointly controlled assets
or jointly controlled operations will be joint operations under
the new standard.

Legal form and contractual arrangements

Other facts and circumstances

The next two steps in determining the classification of

arrangements structured through a separate vehicle are
the legal form of the arrangement and the contractual
arrangements surrounding it. If these give the controlling
parties rights to assets and obligations to liabilities, then the
arrangement is a joint operation.

The final consideration is whether there are any other facts

or circumstances that give the controlling parties rights to
substantially all of the economic benefits of the assets and
make the parties in substance responsible for liabilities.

In some jurisdictions partnership arrangements offer the

parties no separation between them and the vehicle itself. As
a result, such cases would be classified as joint operations
under IFRS 11. Otherwise, we expect that most separate
vehicles will provide legal separation between the parties and
thevehicle.
Contractual arrangements surrounding a joint arrangement
can vary considerably. For example, parties commonly
provide guarantees to third parties for financing provided to
the arrangement. However, a guarantee alone is not in itself
an indicator that the arrangement is a joint operation, as it
does not provide the parties with direct rights to assets and
obligations for liabilities.

When the activities of the arrangement are designed to

provide output to the parties and the arrangement is limited
in its ability to sell to third parties, this indicates that the
parties have rights to substantially all the economic benefits
of the arrangements assets. Such an arrangement also has
the effect that the liabilities incurred by the arrangement
are, in substance, satisfied only by the cash flows received
from the parties through their purchase of the output. When
the parties are substantially the only source of cash flows
contributing to the arrangements operations, this indicates
that the parties have an obligation for the liabilities relating to
the arrangement.

Example
Example 5 of IFRS 11 provides an illustration of a separate vehicle, entity H, undertaking oil and gas exploration, development
and production activity. The main feature of Hs legal form is that H (and not the parties) has the rights to the assets and
obligations for the liabilities relating to thearrangement.
The joint operations contractual agreement specifies that the rights and obligations arising from the joint arrangements
activities are shared among the parties in proportion to their holding in H, and in particular that the parties share the rights
and obligations arising from the exploration and development permits granted to H, the production obtained and all related
costs.
Costs incurred in relation to all work programmes are covered by cash calls on the parties, and in the event that a party fails
to meet its monetary obligations, the other party is required to contribute to H the amount in default; that amount will be
considered debt owed by the defaulting party to the other party.
In this case, the legal form provides the separate vehicle alone with rights to the assets and obligations for the liabilities;
therefore, there is an initial indication that the arrangement is a joint venture. However, as the contractual arrangement
explicitly provides the parties with rights to assets and obligations for liabilities, that initial indication is reversed and the joint
arrangement is determined to be a joint operation.

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How are interests in joint arrangements accounted for?

The table below sets out the accounting for different arrangements.
Consolidated financial statements

Separate financial statements

Joint venturers

Equity method in accordance with IAS28 (2011)

Investments in Associates and Joint Ventures.

Choice between cost or in accordance with

IFRS9 Financial Instruments/IAS39 Financial
Instruments: Recognition and Measurement.

Joint operators

Recognises its own assets, liabilities and transactions, including its share of those incurred jointly.

Other parties to a
joint venture

If significant influence exists, then equity

method in accordance with IAS28 (2011);
otherwise, in accordance with IFRS 9/IAS 39.

Other parties to a
joint operation

If significant influence exists, then choice

between cost or in accordance with IFRS9/
IAS39; otherwise, in accordance with IFRS 9/
IAS 39.

Recognises its own assets, liabilities and transactions, including its share of those incurred jointly, if
it has rights to the assets and obligations for the liabilities.
Otherwise, it accounts for its interest in accordance with the IFRS applicable to that interest, e.g.
IAS 28 (2011) or IFRS 9/IAS 39, as the case may be.

Accounting for joint ventures

IFRS 11 requires equity accounting for joint ventures in
consolidated financial statements. The investment in the joint
venture will be recognised initially at cost and adjusted for
changes in the investors share of the profit or loss of the joint
venture throughout the arrangement.

Accounting for joint operations

In a joint operation each party controls its own assets and has
obligations for expenses it incurs. Therefore, a joint operator
recognises its assets, liabilities, revenues and expenses,
including its share of those held or incurred jointly. These are
accounted for in accordance with the applicable IFRS.
This approach is similar to that in IAS 31 for jointly controlled
assets/jointly controlled operations. Therefore, the accounting
for joint operations not structured through a separate
vehicle is not expected to be significantly different from that
previously applied.

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Accounting for interests in joint arrangements

when you dont have joint control
IFRS 11 also sets out the accounting for joint arrangements
by parties that do not have joint control. An investor in a joint
operation accounts for its investment in the same way as a
joint operator. However, this applies only if the investor has
rights to assets and obligations for liabilities. Otherwise, it
accounts in accordance with the applicable IFRS, e.g. IAS28
or IFRS9/IAS39.
This is a change from the previous requirement to account
for investments in jointly controlled operations/assets in
accordance with IAS 39/IFRS 9, or IAS 28 when significant
influence existed.
IFRS 11 carries forward the existing requirements of IAS31
for parties to joint ventures that do not participate in joint
control; therefore, if IAS 31 jointly controlled entities are
classified as IFRS11 joint ventures, then we do not expect a
significant effect on the accounting by investors.

Read more about the new standard

For a more detailed understanding of the potential effect
of IFRS11, read our publication First Impressions: Joint
arrangements.

Other KPMG publications

A detailed discussion of the general accounting issues
that arise from the application of IFRSs can be found in our
publication Insights into IFRS.
In addition to Insights into IFRS, we have a range of
publications that can assist you further, including:
IFRS compared to US GAAP
Illustrative financial statements for interim and annual
periods
IFRS Handbooks, which include extensive interpretative
guidance and illustrative examples to elaborate or clarify
the practical application of a standard
New on the Horizon publications, which discuss
consultation papers
Newsletters, which highlight recent developments
IFRS Practice Issue publications, which discuss specific
requirements and pronouncements
First Impressions publications, which discuss new
pronouncements, including First Impressions:
Consolidated financial statements

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Publication name: Impact on oil and gas companies

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Publication number: 314758

Publication date: September 2011
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