Before getting into a joint venture, it is important to know the accounting methods to employ. Although there are two methods to record investments in joint ventures, this article will explore the proportionate consolidation method.
Joint Venture
A joint venture is a business arrangement between two or more parties to achieve a specific objective. There are various reasons for entering into a joint venture. For example:
- Mutual benefit – Partners work together to achieve a business objective.
- Share risks and costs – Partners pool their resources such as their assets and as a result, share risks.
- Access to expertise or market – Different partners may contribute different skillsets. The combination of these skillsets and resources will be crucial to the success of the joint venture.
Often, a joint venture agreement between two or more parties will create a separate business entity where the venturers contribute assets to form part of their equity stake. The agreement will outline the rights, liabilities and management of the separate business entity created by the joint venture. This business entity will exist until the joint venture finishes pursuant to the exit strategies outlined in the agreement. You can see a sample of a joint venture agreement in this link.
As a result, there needs to be an accounting method to account for the venturers investment in the joint venture.
There are two accounting methods to use: the equity method and the proportionate consolidation method. To read more on the equity method, you can visit this link.
Proportionate Consolidation on Joint Ventures
Under the proportionate consolidation method, the accounts of the joint venture are consolidated with the venturers balance sheet in proportion to their respective investments. This means that the assets and liabilities of the joint venture product will be included on the venturers balance sheet. Similarly, the income and expenses of the joint venture are recorded on the venturers income statement.
For example, Company X has 50% interest over the joint venture company; Company Y. Subsequently, Company X would record only 50% of Company Y’s assets, liabilities, income, and expenses in their financial statements. So if Company X has assets worth $10 million and Company Y’s assets are worth $5 million, then Company X’s assets in the balance sheet would be listed as $12.5 million.
Supporters of this method argue that the proportionate consolidation method gives a more detailed look into the performance of the joint venture. The proportionate consolidation method breaks down the components of the joint venture into several components.
AASB 128 governs investments in joint ventures. The Australian Accounting Standards Board created a set of rules to regulate accounting practices so that they are consistent and adhere to a certain standard. It provides the details as to employing the proportionate consolidation method and the considerations to take into account. You can visit AASB 128 from this link.
Final Thoughts
To conclude, there are two ways in which investments in joint ventures may be accounted for. You can use the equity method or the proportionate consolidation method. Picking which accounting method you use will impact the way your financial statements perform. Subsequently, to minimise your risk, you can consult a business lawyer.
