Summary: The decision to enter into a joint venture (JV) can have a significant impact on your business, opening new operational capabilities and the ability to compete for new pools of contracts. However, the decisions may also have a significant impact on your financial statements, which can vary greatly depending on how the joint venture is structured.
What is a joint venture?
The Financial Accounting Standards Board (FASB) defines a ‘joint venture’ as follows:
“An entity owned and operated by a small group of businesses (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 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. A joint venture also usually provides an arrangement under which each joint venturer may participate, directly or indirectly, in the overall management of the joint venture. Joint venturers thus have an interest or relationship other than as passive investors. An entity that is a subsidiary of one of the joint venturers is not a joint venture. The ownership of a joint venture seldom changes, and its equity interests usually are not traded publicly. A minority public ownership, however, does not preclude an entity from being a joint venture. As distinguished from a corporate joint venture, a joint venture is not limited to corporate entities.” (See Accounting Standard Update No. 2023-05, Business Combinations – Joint Venture Formation, Subtopic 805-60)
Accounting for a joint venture
The process of accounting for a joint venture can vary greatly based on the facts and circumstances of the joint venture’s setup; the main factor being the percentage ownership that the member has in the JV entity.
Below are three separate ways to account for an investment in a joint venture based on varying levels of ownership.
Financial reporting when you are the majority shareholder (>50%)
As the majority shareholder (greater than 50%) who also maintains control of the JV by holding a majority of the board of directors’ seats, the Company is required to consolidate the financials. This means that the Company consolidates the JV’s financial statements with their own on a line-by-line basis, including all assets, liabilities, revenues, and expenses. The Company will then need to eliminate any intercompany balances, including accounts receivable and accounts payable, revenue and subcontractor costs, as well as investments in joint venture and equity.
Lastly, the Company needs to record amounts attributable to noncontrolling interests, which is the minority shareholder in the joint venture. This includes the noncontrolling interests share of the equity and the noncontrolling interests share of the net income.
The noncontrolling interest shall be reported in the consolidated statement of financial position within equity (net assets), separately from the parent’s equity (or net assets). That amount shall be clearly identified and labeled, for example, as noncontrolling interest in subsidiaries (see paragraph 810-10-55-4I). An entity with noncontrolling interests in more than one subsidiary may present those interests in aggregate in the consolidated financial statements. A not-for-profit entity shall report the effects of any donor-imposed restrictions, if any, in accordance with paragraph 958-810-45-1. (See Accounting Standards Codification [ASC] paragraph 810-10-45-16)
Example Scenario
Company ABC owns 51% of the shares in Joint Venture GovConXYZ, along with two of the three seats on the JV’s board of directors. Based on the above, Company ABC is required to consolidate Joint Venture GovConXYZ’s financials.
For the fiscal year, Joint Venture GovConXYZ had $1,000,000 in net income. As the JV had no agreements stating otherwise, profits of the company are to be recognized in proportion to the shares held by each joint venture partner. To record this consolidation, there are a few basic entries which need to be made, see descriptions of these below:
- Entry 1: As the entities are being consolidated, Company ABC will need to eliminate its investment in the joint venture and Joint Venture GovConXYZ will need to eliminate the corresponding member contributions from Company ABC.
- Entry 2: In many cases, when taking part in a joint venture, the members perform under the joint venture contracts as subcontractors. In this scenario, Company ABC would need to eliminate any revenue attributable to work performed on the JV contracts and Joint Venture GovConXYZ would need to eliminate the associated subcontractor expense from Company ABC.
- Entry 3: The companies would also need to eliminate any due to or due from activities on the respective balance sheets at the reporting date. In this case, Company ABC would eliminate the receivables due from Joint Venture GovConXYZ (for their work on the JV contracts), and Joint Venture GovConXYZ would eliminate the associated accounts payable due to Company ABC.
- Entry 4: As noted above, Company ABC will need to record the interest attributable to their noncontrolling JV partner on the balance sheet and income statement. In this instance, the noncontrolling interest is 49% of the joint venture that Company ABC does not own. Company ABC would record a credit of $490,000 for noncontrolling interest (included in the equity section of the balance sheet) and a debit of $490,000 for net income attributable to noncontrolling interest (included on the income statement).
In addition to these entries made for the face of the financial statements, Company ABC should also record in their footnotes certain information regarding Joint Venture GovConXYZ. This would include the Company’s ownership percentage in the joint venture and the reason for its formation.
Financial reporting when you may exercise significant influence (20-50%)
When a company is not the majority shareholder in an investment (or joint venture) but owns at least 20%, the Company is deemed to have the ability to exercise significant influence and as such, per GAAP, the investment shall be recorded under the equity method.
Under the equity method, an investment in common stock shall be shown in the balance sheet of an investor as a single amount. Likewise, an investor’s share of earnings or losses from its investment shall be shown in its income statement as a single amount. (See ASC paragraph 323-10-45-4)
As noted in the excerpt above, the equity method involves adjusting the Company’s recorded investment in the joint venture by its proportionate share of the net income of the joint venture and reduced by distributions paid from the joint venture to the Company. The calculation will default to the proportion of outstanding shares held unless joint venture agreement states otherwise.
Example Scenario
Company DEF owns 49% of the shares in Joint Venture GovConXYZ along with one of the three seats on the joint venture board of directors. Based on the above, Company DEF has the ability to exercise significant influence over Joint Venture GovConXYZ and is required to apply the equity method.
For the fiscal year, Joint Venture GovConXYZ had $1,000,000 in net income. As the JV had no agreements stating otherwise, profits of the company are to be recognized in proportion to the shares held by each joint venture partner. In this instance, Company DEF would record a debit of $490,000 for investment in joint venture (included in non-current assets on the balance sheet) and a credit for $490,000 for equity in earnings of joint venture (included in other income on the income statement).
In addition to the amounts noted above, which are recorded on the face of the financial statements, Company DEF should also record in their footnotes the percentage ownership in the joint venture, their share of joint venture net income for the months presented and a summary of the joint venture’s financial results (i.e., total assets, total liabilities, equity, revenue, and net income).
Financial reporting when you do not exercise significant influence (<20%)
When the Company has less than 20% interest in an investment (or joint venture) and there is no other evidence of being able to exercise significant influence over the entity (e.g., seats on the board of directors) then the cost method will be utilized to record the investment. Under this method, the investment will be recorded at cost and not be adjusted until sold. However, during each reporting period the Company will need to consider if the investment is impaired. This is when the fair value of the investment drops below the carrying value of the investment on the Company’s books.
Additional considerations
Certain situations arise where the percentage of ownership would not dictate how the investment should be treated. The most notable example revolves around being able to exercise significant influence through board seats. In the instance where a company owns over 51% of the joint venture but the JV partner holds most seats on the board of directors, then the majority shareholder company would ultimately would not consolidate the JV and would instead apply the equity method as described above. Conversely, the minority shareholder would consolidate as they are the controlling entity through board seats.
Final thoughts
Entering a joint venture can benefit your company greatly, however there can be a significant impact on your financial statements.
The formation and operation of a joint venture require careful consideration of the financial reporting implications under relevant accounting frameworks such as US GAAP and IFRS. Decisions around equity participation, board composition, and contractual rights will influence whether you consolidate, apply the equity method, or record the investment at cost. It’s important to have a clear understanding of these reporting models and how to account for intercompany transactions, noncontrolling interests, and the appropriate disclosures.
Empower your organization to make informed decisions by understanding the operational and financial impacts joint ventures can have on your business. Aprio can help you stay ahead of reporting requirements and bring clarity to your financial disclosures.
