Accounting for Joint Venture
Joint Venture is a contractual agreement between multiple owners who share control over a task such as company, economic activity, operation, or assets. The task can be the registered company or just an operation activity. Two or more parties agree to use their capital to operate the company and share profit together.
Joint venture is an agreement where parties have joint control over the arrangement and have access to the network access of the arrangement.
All parties will contribute the capital including cash, fixed assets, and other resources. The ownership of the company depends on the percentage of the capital invested. Subsequently, the company may require further investment and they will raise capital based on the ownership percentage. If the company doing well and makes a good profit, they may share some profit. All partners may withdraw some cash and share based on the ownership percentage.
For example, Company ABC and Company XYZ own company Z with a percentage of 50%-50%. Both companies have contributed $ 5 million each to start the company. After 5 years, company makes a good profit, so the owner decides to withdraw $ 1 million. $ 500,000 will be allocated to Company ABC and another $ 500,000 to Company XYZ.
Joint Venture Feature
- Agreed purpose: all parties who own the joint venture have the same goal or purpose.
- Create Synergy: The venture will contain the goods part from all owners.
- Share Profit/Loss: profit and loss will share with the owners depending on the percentage of ownership. They need to take risks and rewards from the investment.
- Share Control: All owners will joint control to ensure that the company achieves its objective.
- Share Expertise & Resource: The expertise and resources will be allocated to the joint venture based on the agreement.
- Limited Time: Joint ventures only last for a specific time period in the agreement.
Accounting Treatment for Joint Venture
The owners of a joint venture can recognize their investment using the equity method while the proportionate consolidation is no longer allowed by the IASB.
Equity method is the accounting method that the parent company needs to record investment which has significant influence or joint control. If the parent has full control over the investment, equity will not applicable, the company must consolidate the financial statement.
Equity method requires the company to record the following:
Initial Recognition of Joint Venture
The company needs to record the initial investment at a cost usually equal to the common stock of the joint venture. The cost of investment includes other fees which contribute directly related to the investment. It includes transaction cost, legal fee, accounting fee but excludes the internal cost.
If the company invests in the joint venture by using non-cash assets, they must be recorded using fair value. The company must access the asset’s value by comparing it with similar items in the market.
The company should make journal entry by debiting investment in joint venture which is the asset on balance sheet and credit cash or non-cash assets.
| Account | Debit | Credit |
|---|---|---|
| Investment in Joint Venture | 000 | |
| Cash | 000 |
Subsequent Measurement of Joint Venture
The investment must be adjusted with current profit or loss of the joint venture. Net income of the joint venture will increase the investment account by the proportion of share ownership. On the other hand, the investment will decrease due to the joint venture loss. The increase or decrease of investment will not impact the percentage of ownership over the joint venture. All parties will increase or decrease by the same portion of their ownership.
- Record Profit from investment in Joint Venture: The company simply debit the investment in joint venture and credit profit into the income statement.
| Account | Debit | Credit |
|---|---|---|
| Investment in Joint Venture | 000 | |
| Profit from Investment | 000 |
- Record Loss from Investment in Joint Venture: Company make journal entry by debiting loss into the income statement and credit investment from the balance sheet.
| Account | Debit | Credit |
|---|---|---|
| Loss from Joint Venture | 000 | |
| Investment in Joint Venture | 000 |
- Record Cash Dividend from Investment in Joint Venture: When all parties agree to share the dividend, they will receive the portion based on the percentage ownership. Each company needs to debit cash and credit the investment in joint venture.
| Account | Debit | Credit |
|---|---|---|
| Cash | 000 | |
| Investment in Joint Venture | 000 |
Disposal of Joint Venture
The investment in joint venture needs to be derecognized when the company sells the investment. The investment will be deducted by the sale proportion, if the company sells a whole investment, it needs to deduct the whole amount as well. The difference between book value and consideration receive will consider as the gain or loss.
| Account | Debit | Credit |
|---|---|---|
| Cash | 000 | |
| Investment in Joint Venture | 000 | |
| Gain from sell of investment | 000 |
Example of Joint Venture
Company EFG and MNO Corp have joined together to create company S. Both parents have invested $ 5 million each into Company S.
- At the end of 1st year, company S lose $ 2 million
- At the beginning of 2nd year, Company EFG decide to sell 40% of the investment in S for $ 1.5 million
- At the end of 2nd year, company S make a profit of $ 4 million, and management decides to share a dividend $ 1 million to shareholders. EFG decide to sell the remaining share in S for $ 4 million.
Please record the transaction for Company EFG related to the investment in Joint Venture.
EFG and MNO Corp have invested in the joint venture (company S), so both partners must use the equity method to record the investment. The investment needs to record at cost and subsequently adjust with profit and loss of the jointed company.
- Initial record: Company EFG invest $ 5 million which equals 50% shares of company S.
| Account | Debit | Credit |
|---|---|---|
| Investment in Joint Venture | 5,000,000 | |
| Cash | 5,000,000 |
- At the end of 1st year: Company S Lose $ 2 million. EFG investment will reduce $ 1 million as it has 50% shares in S ( $ 1 million = $ 2 million * 50%).
| Account | Debit | Credit |
|---|---|---|
| Loss from Joint Venture | 1,000,000 | |
| Investment in Joint Venture | 1,000,000 |
- At the beginning of 2nd year: EFG decide to sell 40% of its investment for $ 1.5 million.
40% of book value investment equal $ 1.6 million ($ 4 million * 40%). So it means the EFG lose $ 0.1 million from sale proceed.
| Account | Debit | Credit |
|---|---|---|
| Cash | 1,500,000 | |
| Loss from Sale of Joint Venture | 100,000 | |
| Investment in Joint Venture | 1,600,000 |
- At the end of 2nd year: company S make a profit of $ 4 million. EFG needs to record 30% of profit as its shares remain only 30% after selling. (30% = 50% * 60%)
| Account | Debit | Credit |
|---|---|---|
| Investment in Joint Venture | 1,200,000 | |
| Profit from Investment | 1,200,000 |
Record cash dividend: 30% of $ 1 million
| Account | Debit | Credit |
|---|---|---|
| Cash | 300,000 | |
| Investment in Joint Venture | 300,000 |
- EFG sell the remaining shares
Book value = $ 5 million – $ 1 million – $ 1.6 million + $ 1.2 million – 0.3 million = $ 3.3 million
Gain = Consideration – Book value = $ 4 million – $ 3.3 million = $ 0.7 million
| Account | Debit | Credit |
|---|---|---|
| Cash | 4,000,000 | |
| Investment in Joint Venture | 3,300,000 | |
| Gain from sell of investment | 700,000 |
Advantage of Joint Venture
- Share capital: Starting up a new company requires huge capital and it is very hard for small investors. The joint venture allows two or more parties to share the resources and start a company.
- Share Technical: A company requires many technical skills which makes it hard to recruit the right people. Some technical skills are not available in the market, they are exclusive to any company. If we joint venture with that company, we will be able to access such kind of technical. It will help to improve the company’s growth.
- Economic of Scale: Big companies can take advantage of economies of scale in the purchase of materials or services.
- Easy to sell: Joint venture is completely separate from the main company, in both structure, ownership, and business operation. So it is easy for the owner to sell the joint venture from one to another owner.
- Enhance brand name: Joint ventures can take advantage of the owner branding which enables them to join the market very quickly. It can attract customers by utilizing good branding from the owner.
- Win-win solution: Joint ventures are usually made between a small company and a large corporation. It allows the small company to gain access to financial resources while allowing a big corporation to gain access to expertise that may take years to acquire.
Disadvantage of Joint Venture
- Different Management Style: There will be a conflict between two parties that have different leadership styles. It is not easy to combine the leadership from two existing companies to work in a new company. It would be great if all the partners had similar cultures.
- Imbalance Contribution: There is no such thing called equal contribution when it comes to joint ventures. One partner may contribute technical skills, expertise, and leadership while the other contributes cash. So it is hard to evaluate the non-cash contribution.
- Conflict of Interest: At any point in time, the joint venture interest can conflict with the partners’ main business. So It will become a problem as the owners may ignore the joint venture benefits while it has a greater impact on their main benefit. As a result, it will cause further conflict with other partners.
