CHAPTER ONE
Joint Arrangements
Objectives:
At the end of this chapter, you will be able to:
define joint venture
discuss the features of joint ventures
identify the types of joint ventures and their accounting treatments
Discuss accounting for investments in joint ventures.
Q. What We Mean by Joint Ventures?
1.1 Definition
A joint venture is often defined as a contractual arrangement involving the cooperative efforts
and the utilization of the resources of two or more ventures to accomplish an agreed-upon
goal.
In a joint venture arrangement, the participating ventures generally decide major policies
concerning the undertaking by mutual agreement.
The legal form chosen for a particular joint venture arrangement results from a consideration
of the relationship desired by the participating ventures within parameters set by the
objectives of the venture, enterprise law of the country of operation, tax law, business
environment, and so forth.
Joint ventures are often created in the form of contractual arrangements for carrying out
specific activities without forming a separate organizational structure.
1.1.1 Back ground of JVs
A joint venture is a form of partnership that originated with the maritime trading
expeditions of the Greeks and Romans.
The objective was to combine management participants capital contributors in undertakings
limited to the completion of specific trading projects.
In an era when marine transportation and foreign trade involved many hazards, individuals
(venturers) would band together to undertake a venture of this type.
The capital required usually was larger than one person could provide, and the risks were too
high to be born alone.
~1~
Because of the risks involved and the relatively short duration of the project, no net income
was recognized until the venture was completed.
At the end of the voyage, the net income or net loss was divided among the venturers, and
their association was ended.
Today the joint venture takes many different forms, such as
Partnership
Corporate
Domestic and Foreign,
Temporary as well as relatively permanent.
The joint venture enables several participants to share in the risks and rewards of
undertakings that would be too large or too risky for a single venture.
It also enables them to combine technology, markets and human resources to enhance the
profit potential of all participants.
In today's business community, joint ventures are less common but still are employed for
many projects such as:
1) The acquisition, development and sale of real property
2) Exploration for oil and gas and
3) Construction of bridges, buildings and dams.
1.1.2 Nature of Joint Venture Businesses
Considering the nature of joint venture arrangements, joint ventures can be classified as
belonging to one of the following types.
1) Jointly controlled entities
2) Jointly controlled operations
3) Jointly controlled assets
1. Jointly controlled entities
Maintains its own accounting records
Prepares and presents financial statements in the same way as other entities in
conformity with the appropriate accounting standards.
Generally, jointly controlled entities may be divided into two forms:
a) Incorporated and
b) Unincorporated
~2~
a) Incorporated
The incorporated entities, i.e. corporations are juridical persons.
An incorporated entity owns assets, incurs liabilities and expenses, and earns revenues
in its own name and for its own account.
Being a legal person, an incorporated entity has the right to enter into contract in its
own name, it can sue and it can be sued.
b) Unincorporated
Ordinarily, an unincorporated entity is not treated as a legal person.
Although the unincorporated entity can in its name acquire assets, incur liabilities and
conduct business operations, from a legal point of view, the owners of the entity are
directly and proportionately in control of all the assets and liabilities.
2. Jointly Controlled Operation
In this situation no separate entity is formed.
Instead, parts of the venturers’ existing enterprise work on a common project and
coordinate their activities.
The organizational structure remains flexible. In some case joint “project teams” are
formed, in others responsibilities are delegated as and when the need arises.
The distinctive feature of this type of joint venture is that the assets and expertise assigned
by each venturer for the joint venture activity remain under the direct control of the
venturer who assigns them.
The participating venturers perform their respective parts of the joint venture actively
using their own resources.
The benefits are shared by the venturers on an agreed basis.
Examples of joint venture operations include those joint venture arrangements under which the
venturers jointly produce market and distribute a particular product using each venturer’s
resources such as its property, plant and equipment, technical expertise and employees.
3. Jointly Controlled Assets
Although these are not separate legal entities, the resources contributed by the
participating venturers are combined together for the purpose of a joint venture project
which is managed either by:
One venturer typically known as operator, or
A joint management’s team.
~3~
The joint venture agreements define the responsibilities and obligations, of the operator,
the interest of the parties etc.
The distinctive feature of a joint venture of this type is that each venturer possesses an
undivided interest in its assets.
The costs of running the project are shared by the participating ventures on an agreed
basis.
This type of joint venture arrangements is prevalent in the extractive industries (eg. oil,
gas, and minerals).
Example of a jointly controlled assets venture is where two or more oil exploration companies
enter into a joint arrangement to undertake oil exploration or to build an oil pipeline.
1.1.3 Accounting by Joint Venturers
Although different countries have different accounting standards, in the case of international joint
ventures, it is necessary that the accounting practices of these joint ventures not only conform to
the national accounting standards of the host countries but also provide useful information for the
foreign venturers. This can best be accomplished by using internationally accepted accounting
standards. The accounting procedures in the case of each of the three types of joint ventures are
described below.
1. Accounting by Jointly Controlled Entities
If all the venturers provide cash for ownership interest in the joint venture, the accounting for
preparation of the opening balance sheet of this enterprise is fairly simple. If the venturers
contribute only non-monetary assets (assets other than cash) or cash plus some non-monetary
assets, the fair market value of each non-monetary asset needs to be estimated. An independent
appraisal of the non-monetary assets maybe required in cases where their values are not apparent
from other sources. After preparation of the opening balance sheet of the jointly controlled entity,
normal accounting in accordance with the generally accepted accounting principles in the country
of operation is applied to the future transactions.
The ending balance of each venturer’s capital account shown in the statement of venturers’
capital, should be reported against each venturer’s name in the “venturer’s capital section” of the
balance sheet.
~4~
Illustration on unincorporated joint venture
A Corporation and B Corporation formed an unincorporated joint venture on January 1,2006.
They agreed to share profits or losses equally. A Corp. contributed Br.1 million in cash. B corp.
contributed an ongoing business as to which the only tangible assets are fixed assets with an
original cost of Br.800,000 and accumulated depreciation of Br. 200,000 equaling a net book
value of Br.600,000. The fixed assets contributed by B corp. have a market value of Br.850,000.
Since the fair market value of each participant’s contribution is considered to be equal to A
corp.’s cash contribution of 1 million, the business contributed by B corp. is considered to include
joint concern value giving rise to goodwill of Br.150,000. They decided to amortize the goodwill
over 40 years, i.e. Br. 3,750 per year.
The formation of the joint venture A&B Corp. was recorded with the following journal entry:
Cash -------------------------------------------------------1,000,000
Fixed assets ------------------------------------------------850,000
Goodwill ---------------------------------------------------150,000
A Capital 1,000,000
B Capital 1,000,000
(To record the investment by the venturers)
The joint venture operated in 2006 and its condensed financial statements for the year
2006 were as follows:
A&B Corporation (A joint venture)
Income statement
For the year ended, December 31, 2006
Revenue Br.5,000,000
Costs and expenses 4,000,000
Net Income 1,000,000
Division of net income
A Br. 500,000
B Br 500,000
Total Br.1, 000,000
A&B Corporation(A joint venture)
Statement of Venturer’s capital
For the year ended, December 31, 2006
A B Combined
Investments, Jan. 1, 2006 Br. 1,000,000 Br.1,000,000 Br.2,000,000
Add: Net income 500,000 500,000 1,000,000
Venturer’s capital at end of year Br.1,500,000 Br.1,500,000 Br.3,000,000
~5~
A&B Corporation(A joint venture)
Balance Sheet
December 31, 2006
Assets
Current assets Br.3,200,000
Other assets (including unamortized goodwill) 4,800,000
Total assets 8,000,000
Liabilities and venturer’s capital:
Current liabilities 1,600,000
Long-term debt 3,400,000
Venturer’s capital:
A 1,500,000
B1,500,000 3,000,000
Total liabilities and venturer’s capital Br. 8, 000,000
If the jointly controlled entity is an incorporated one, i.e. a corporation, its financial reporting and
accounting procedures should follow the conventional or legal requirements on corporate
accounting in the country of operation. In the case of financial reporting by international joint
ventures whatever their form, international standards are to be taken as “benchmarks” which will
be adjusted or modified to suit the local environment.
2. Accounting by Jointly Controlled Operations
In this type of joint venture, no separate accounts of the joint venture operations are prepared.
Therefore, the question of accounting by joint ventures does not arise. Each venturer maintains
accounting records for its part of a joint venture operation, which will be discussed under the
topic accounting for investments in joint ventures.
3. Accounting by Jointly Controlled Assets
These joint ventures normally maintain separate accounting records of the expenses incurred for
the outputs delivered to the joint venture participants. These accounting records are maintained
by the operator of the undertaking. In most cases, the joint venture agreement may include an
accounting agreement. The main provisions of the accounting agreement encompass the approval,
funding, reporting, allocation, charging and audit of expenditures applicable to the joint venture.
Generally, the operator is given authority to commit and incur expenditures by virtue of an
approved AFE (authority for expenditure) within the agreed work program and budget. An AFE
covers a particular activity. The AFE is normally broken down and reported against controllable
cost categories. As a result, a measure of control is exerted by the venturers (non-operators),
whilst allowing the operator the flexibility to perform the task. Any revisions to the work
program and budget are to be approved by the venturers periodically.
~6~
1.1.4 Accounting for Investments in Joint Ventures
Generally accepted accounting principles (GAAP) recognize three different approaches to the
financial reporting of investments in corporate equity securities:
• Fair-value method.
• Proportionate consolidation method.
• Equity method.
Fair-Value Method
In many instances, an investor possesses only a small percentage of an investee company’s out-
standing stock, perhaps only a few shares. Because of the limited level of ownership, the
investor cannot expect to significantly affect the investee’s operations or decision making. These
shares are bought in anticipation of cash dividends or in appreciation of stock market values.
Such investments are recorded at cost and periodically adjusted to fair value according to the
Financial Accounting Standards Board (FASB).
Proportionate consolidation method
Many corporate investors acquire enough shares to gain actual control over an investee’s
operation. In financial accounting, such control is recognized whenever a stockholder ac-
cumulates more than 50 percent of an organization’s outstanding voting stock. At that point,
rather than simply influencing the investee’s decisions, the investor clearly can direct the entire
decision-making process.
Equity Method
Another investment relationship is appropriately accounted for using the equity method. In many
investments, although control is not achieved, the degree of ownership indicates the ability for the
investor to exercise significant influence over the investee.
The Equity and Proportionate methods illustrated
The two methods may be illustrated by assuming that Addis Co and Berta Co each invested
$400,000 for a 50% interest in an unincorporated joint venture on January 2,2001. Condensed
financial statements for the joint venture, Addis Berta Co, for 2001 were as follows:
~7~
Addis Berta Co(A joint venture)
Income statement
For the year ended December 31, 2001
Revenue $2,000,000
Costs and expenses 1,500,000
Net Income 500,000
Division of net income
Addis co. $ 250,000
Berta co. 250,000
Total $500,000
Addis Berta Co(A joint venture)
Statement of Venturer’s capital
For the year ended, December 31, 2001
Addis Co Berta Co. Combined
Investments, Jan. 2, 2001 $400,000 $400,000 $800,000
Add: Net income 250,000 250,000 500,000
Venturer’s capital at end of year$650,000 $650,000 $1,300,000
Addis Berta Co(A joint venture)
Balance Sheet
December 31, 2001
Assets
Current assets $1,600,000
Other assets 2,400,000
Total assets 4,000,000
Liabilities and venturer’s capital
Current liabilities 800,000
Long-term debt 1,900,000
Venturer’s capital:
Addis co 650,000
Berta co 650,000 1,300,000
Total liabilities and venturer’s capital $4,000,000
Under the equity method of accounting, both Addis co. and Berta co. would prepare the following
journal entries for the investment in AddisBerta Company:
Journal entries for unincorporated joint venture under equity method of accounting,
January 2, 2001.
Investment in Addis Berta Co 400,000
Cash 400,000
To record investment in joint venture
Dec. 31, 2001
Investment in Addis Berta Co 250,000
Investment Income 250,000
To record share of AddisBerta Co. net income (50% x 500,000)
~8~
Under the proportionate share method of accounting, in addition to the two foregoing journal
entries, both Addis and Berta companies would prepare the following journal entry for their
respective share of the assets, liability, revenue, and expense of AddisBerta Company:
Additional venturer's journal entries for unincorporated joint venture under proportionate share
method of accounting,
December 31, 2001
Current assets (1,600,000 x 0.5) 800,000
Other assets (2,400,000 x 0.5) 1,200,000
Costs and expenses (1,500,000 x 0.5) 750,000
Investment income 250,000
Current liabilities (800,000 x 0.5) 400,000
Long-term debt (1,900,000 x 0.5) 950,000
Revenue (2,000,000 x 0.5) 1,000,000
Investment in Addis Berta co 650,000
(To record proportionate share of joint venture's assets, liabilities, revenue and expenses)
~9~