IB Manual – Accounting for Joint Ventures and Associates

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.

Associates accounting

Significant influence

An associate is an entity over which an investor exerts significant influence. It is neither a subsidiarySubsidiaryA subsidiary (sub) is a business entity or corporation that is fully owned or partially controlled by another company, termed as the parent, or holding, company.  Ownership is determined by the percentage of shares held by the parent company, and that ownership stake must at least 51%. nor an interest in a joint ventureJoint Venture (JV)A joint venture (JV) is a commercial enterprise in which two or more organizations combine their resources to gain a tactical and strategic edge in the market. Companies often enter into a joint venture to pursue specific projects. The JV may be a new project or new core business.

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 processesCorporate StrategyCorporate Strategy focuses on how to manage resources, risk and return across a firm, as opposed to looking at competitive advantages in business strategy
• Material transactions between the investor and the investee
• Provision of essential technical information

Equity accounting

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 interestsStockholders EquityStockholders Equity (also known as Shareholders Equity) is an account on a company's balance sheet that consists of share capital plus retained earnings. It also represents the residual value of assets minus liabilities. By rearranging the original accounting equation, we get Stockholders Equity = Assets – Liabilities. 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.

Additional resources

Thank you for reading this section of CFI’s free investment banking bookInvestment Banking ManualCFI's Investment Banking book is free, available for anyone to download as a PDF. Read about accounting, valuation, financial modeling, Excel, and all skills required to be an investment banking analyst. This manual is 466 pages of detailed instruction every new hire at a bank needs to know to succeed on associates and joint venture accounting. To keep learning and advancing your career, the following CFI resources will be helpful:

• Financial Modeling GuideFree Financial Modeling GuideThis financial modeling guide covers Excel tips and best practices on assumptions, drivers, forecasting, linking the three statements, DCF analysis, Excel modeling and much more. Designed to be the best free modeling guide for analysts by using examples and step by step instructions. Investment banking, FP&A, research
• Equity MethodEquity MethodThe equity method is a type of accounting used in investments. This method is used when the investor holds significant influence over investee, but not full control over it, as in the relationship between parent and subsidiary. This differs from the consolidation method where the investor exerts full control
• Strategic AlliancesStrategic AlliancesStrategic alliances are agreements between independent companies to cooperate in the manufacturing, development, or sale of products and services.
• Real Estate Joint VentureReal Estate Joint VentureA Real Estate Joint Venture (JV) plays a crucial role in the development and financing of most large real estate projects. A joint venture is a business arrangement in which two or more parties agree to combine their resources in order to accomplish a specific task.