Joint ventures are commonly known as equal investments in a new entity. However, the definition and accounting treatment of a joint venture does not require equal investment and ownership stakes in the joint entity.
Joint ventures can be in the form of partnerships, for projects, or for any other investment purposes. The accounting for joint ventures under the US GAAP rules is considered using the equity accounting method.
Let us discuss the accounting treatment of joint ventures using the US GAAP rules guidelines.
Accounting for Joint Venture – US GAAP Rules
A joint venture can typically be formed when two or more investors arrange a new investment. The new entity can be for a specific project, a limited partnership, or any other form of joint operations.
A joint venture requires accounting for using the equity method of accounting under the US GAAP rules. The equity method defines some rules to identify the joint venture, joint control, or significant influence over the newly established entity.
A joint venture basically can take the form of:
- Jointly conducted operations
- Jointly controlled assets
- Jointly controlled entities
Identifying a Joint Venture – ASC 323
The first step in applying for accounting rules is to identify a joint venture. Unlike a common notion, two entities do not require to share equal (50%) shares in a jointly owned entity. The proportion of control or ownership can differ.
ASC 323 provides guidance to identify the joint venture as:
“A corporation owned and operated by a small group of entities (the joint venturers) as a separate and specific business or project for the mutual benefit of the members of the group. A government may also be a member of the group. The purpose of a corporate joint venture frequently is to share risks and rewards in developing a new market, product or technology; to combine complementary technological knowledge; or to pool resources in developing production or other facilities”.
Joint venture entities are usually non-public entities. Their stock ownerships also do not change frequently as they are held for specific purposes.
A common feature in a joint venture is the active participation of all entities in controlling the affairs of the venture. Each party involved in the venture can directly or indirectly influence the venture. However, a subsidiary owned by one of the owners of the joint venture cannot be considered itself as a joint venture.
The term joint control closely resembles the definition of joint control. The SEC guides on the definition of joint control as an ability to influence the decision-making process of the entity.
Apart from that, both entities may enter into a short-term or long-term arrangement to jointly control the entity. They contribute resources to gain control over the joint entity. Usually, the joint control exists in the proportion of voting rights held by the investors.
Initial Recognition and Measurement
The ASC 323 guides on the initial recognition and measurement of a joint venture.
An investor shall record the initial investment in common stocks of an investee including a joint venture at cost in accordance with the ASC 805 guidelines.
ASC 805 states that the cost of acquisition in a joint venture (or any other investment) includes the consideration paid, transfer of assets, contribution in cash form, etc. The consideration costs will include legal fees, transaction costs, and other associated costs with the transaction.
If the investor acquires an investment or joint venture in the form of non-cash payment such as transfer of assets, it must be recorded at a fair value of the acquisition. The investor may record the fair value of the assets transferred or the fair value of the acquired equity whichever is more suitable.
A business may contribute a subsidiary or assets that constitute a business. It means a parent company can start a joint venture by the deconsolidation of a subsidiary as a payment consideration. In this case, ASC 810-10-40 guides on the recognition of the contribution at fair value.
The parent company shall record a net gain or loss on the deconsolidation of the subsidiary in its books according to the guidelines of ASC 810-10-40-5.
The net gain or loss will be measured as the difference of the aggregate of the following:
- The fair value of the consideration received
- The fair value of the retained interest in the former subsidiary
- The carrying amount of the non-controlling interest held in the former subsidiary
The aggregate of all of these would be compared against the former subsidiary’s assets and liabilities.
Subsequent Measurement and Changes in Control
The investors must realize gains or losses on their investment using the proportion of their investment in the common stocks. For instance, if an investor holds 40% of the joint venture, it must account for the 40% of gains or losses incurred by the joint venture subsequently.
The gains or losses arising due to continuous operations of the joint venture do not affect the shareholding of the investors usually. It is a common practice that the investors keep the same proportion of investment in a joint venture until its dissolution.
The ownership of the investor may change only with a capital call made by the joint venture. For example, if an investor contributes further cash as a capital investment that entitles it for additional 5% common stocks, its proportionate shareholding will change. Similarly, a share buyback may result in a reduction in the shareholding rights of the investor.
A change in the ownership rights may require the investors to reassess their ability to influence the decisions of the joint venture. A reduced weightage in the ownership rights may also result in non-participation in the board meetings. Thus, it will require a reassessment as if the joint entity would still qualify as a joint venture.
Dissolution of the Joint Venture
When a joint venture is dissolved, its net assets can be sold to a third party or distributed among the investors. Generally, the investors would receive the net of assets in the proportion of their common stock ownership.
Suppose two businesses A and B found a joint venture C. The joint venture has net assets of $ 400 million at fair value and $ 300 million at book value.
Suppose companies A and B hold 50% common stocks each. The investment held is accounted for as a joint venture. If company A wants to sell its 50% common stocks, the joint venture will be dissolved.
Company A will record the following transactions in its account books.
DR Net Assets (or considerations Received) $ 200 million
CR Investment in C $ 150 million
CR Gain on Investment $ 50 million
Significant Influence and Joint Venture
An investor may hold a significant investment in another entity. It may not be a joint venture with another business. In such cases, the investor would account for the investment using the significant influence wording rather than a joint venture.
Either way, the accounting method will be treated as the equity method of accounting. The investor would use the proportion of shareholding in the entity to calculate its net gains or losses in the entity.
Generally, if an investor holds around 20% of the common stocks of an entity, it is supposed to have a significant influence.
Along with the ownership rights in percentage terms of common stocks, we can use a few other indicators to identify the significant influence of an investor.
- Participation in board meetings and decision-making process
- Material transaction; this typically between the investor and the investee
- Offering technical assistance to the investee
- Offering significant support in terms of human resources or assets
Suppose a group of companies Blue Star group holds an investment in a joint venture techno blue through its company A. For simplicity, let us assume it holds 50% shares of techno blue.
Let us see how company A, the joint venture techno blue, and the Blue Star Group will account for the consolidated profits and loss using joint venture accounting guidelines.
|Details (in $)||Company A||Techno Blue||50% Proportion||Green Star Group|
Similarly, company A and the Green Star Group can account for the initial investment at its cost. They can adjust for the subsequent profit and losses at fair values as discussed above.
Finally, the dissolution of the joint venture will also be accounted for using the fair value of the net assets or the consideration received by company A and subsequently the Green Star Group.