Associates & Joint Venture Accounting
Associates and joint venture accounting is an important topic for financial analysts to understand. Joint ventures (JVs) are accounted for using equity accounting (same as associates), but also occasionally using the proportional consolidation method. This guide will walk you through the basics of associates and JV accounting.
If an investor controls 20% or a greater amount of voting power over the investee – regardless of whether its ownership/control is direct or indirect – then the investor is considered as having significant influence – unless there are some other factors that significantly affect (reduce) the investor’s control.
Possible indicators of significant influence include:
- Participation in policy-making processes
- Material transactions between the investor and the investee
- Provision of essential technical information
Under the equity method, an investment in an associate is:
- Initially recognized at cost
- Increased or decreased to recognize profit or loss of the investee after the date of acquisition
When potential voting rights exist, the investor’s profit or loss in the investee and changes in the investee’s equity are determined according to existing ownership interests. It does not reflect the possible exercise or conversion of potential voting rights. Goodwill can arise on the acquisition of an interest in an associate investment in the same way as in the acquisition of a subsidiary.
Considerations for investment banking
Standard net debt calculations include only the borrowings of the parent and its subsidiaries. Normally, lenders to an associate lack legal recourse to the group regarding its debt, so debt accounting is separate between entities. However, if a company’s associate is strategically important, the entire group may see their financial position called into question if the associate defaults. A default by the associates may affect ratings from agencies such as Standard and Poor’s and Moody’s.
Joint venture accounting (JV)
A joint venture (JV) is a contractual arrangement whereby two or more parties agree to share control over an economic activity. The parties do not merge.
Joint ventures may take many different forms and structures:
- Jointly controlled operations
- Jointly controlled assets
- Jointly controlled entities
A venturer should recognize its interest in a jointly controlled entity using either:
- Proportionate consolidation, OR
- Equity accounting
Proportional Consolidation Method of Joint Venture Accounting
Joint ventures are accounted for using equity accounting (same as associates), but also occasionally using proportional consolidation. An illustration of proportional consolidation is presented here.
The example below is an illustration of how a 50% joint venture would be proportionally consolidated into the group accounts. The joint venture is brought into the group accounts on a proportionate line by line basis between sales and net income.
Thank you for reading this section of CFI’s free investment banking book on associates and joint venture accounting. To keep learning and advancing your career, the following CFI resources will be helpful: