Investments (Part 3) -- Joint Ventures

IFRS Definition and Description

-- IFRS defines a joint venture as "a contractual agreement whereby two or more parties undertake an economic activity that is subject to joint control." IFRS distinguishes three types of joint ventures: 1. Jointly controlled entity -- wherein the joint venture activity is carried out through a separate entity (corporation/company or partnership); 2. Jointly controlled operation -- wherein each party to the joint venture uses its own assets for a specific project; no separate entity is formed; 3. Jointly controlled assets -- wherein a project is carried out with assets that are jointly owned, but no separate entity is formed. 4. Special accounting guidance is provided only for jointly controlled entities.

In what forms may a joint venture be established?

1. By agreement or contract alone; 2. As a corporation; 3. As a partnership; 4. As an undivided interest entity.

What are the major differences between U.S. Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS) in accounting for joint ventures?

1. Contributions of nonmonetary assets: - U.S. GAAPat carrying value; - IFRSat FV for share not owned by contributing entity, with gain/loss recognized. 2. Methods of Reporting: - U.S. GAAP - primarily using equity method; partnership or full consolidation basis when appropriate; - IFRS - equity method or proportionate consolidation.

Joint Ventures -- Description

1. The association created by a joint venture may be established by agreement or contract alone, or may take the form of a legal entity. For example, the joint venture may be formalized as a partnership, a corporation, or other business form (e.g., undivided interest entity).

Joint Ventures -- Description

2. Whatever the form, joint control by two or more investors is central to a joint venture association, generally with no single party having unilateral control. Usually, there are few investors/owners; often there are only two investors/owners. The joint venture agreement will specify how management will be shared, the responsibilities of the parties, and how the outcomes of the venture, including profits and losses, will be shared between or among the parties.

Jacko, Co., a 50% owner of Venture Co., a jointly controlled entity, contributed to Venture a nonmonetary asset with an original cost of $200,000, accumulated depreciation of $50,000, and a fair value of $180,000. Under IFRS, which one of the following is the amount of gain, if any, Jacko should recognize on its contribution to Venture Co.?

A gain should be recognized by Jacko for the share of ownership held by others (50%) attributable to the excess of the fair value of the asset over its carrying value. The excess of fair value ($180,000) over carrying value ($200,000-$50,000 = $150,000) is $30,000 ($180,000- $150,000). Therefore, Jacko should recognize .50 x $30,000 = $15,000 as a gain.

Accounting Subsequent to Formation

Accounting Subsequent to Formation -- Following the formation of a joint venture, the accounting by the investor will depend on the form of the joint venture (e.g., corporation or partnership) and, if a corporation, the relationship between the investor and the joint venture investee.

Joint Venture Accounting at Formation

Accounting at Formation -- An investor records its contribution of assets to a joint venture as an investment at the carrying value of the assets on its books at the time of contribution.

IFRS Joint Venture Accounting -- Accounting at Formation

Accounting at Formation -- Unlike U.S. GAAP, under IFRS when an investor contributes non-monetary assets (e.g., property, plant or equipment) for an equity interest in a jointly controlled entity, the investor generally recognizes in income the portion of any gain or loss (i.e., fair value not equal to carrying value) on the asset that is attributable to the other shareholders in the joint venture.

Joint Venture

An association of two or more entities that exercise joint control over an undertaking for profit generally set up for a limited purpose, a limited time, or both.

Which one of the following is the most likely characteristic of a business joint venture? A. Profits and losses are shared equally. B. Control is shared jointly by parties to the venture. C. Must be established for a limited time. D. Must be formed as a corporation.

C. is Correct! Shared control is a central characteristic of a joint venture. None of the participating parties is likely to have unilateral control of the joint venture.

Corporate Joint Venture Example of Accounting at Formation

Corporate Joint Venture Example -- Example: Facts: Jay, Inc. and Vee, Inc. enter into an agreement to establish JV, Inc., a corporate joint venture. Each party will contribute cash and land or equipment to the venture. Jay contributes $50,000 cash and land with a carrying value of $25,000 and a fair value of $30,000. Jay Entry: DR: Investment in JV, Inc., Joint Venture $75,000 CR:Cash $50,000 CR:Land 25,000

Corporate Joint Ventures

Corporate Joint Ventures -- How an investor accounts for and reports its investment in the common stock of a corporate joint venture will be determined first by whether the joint venture entity is a variable interest entity (VIE) or not.

Under U.S. Generally Accepted Accounting Principles (GAAP), what are the methods of accounting that may be used to report an investment in a joint venture?

Equity method or consolidation basis for a corporate joint venture. Partnership basis, with certain equity method-like adjustments, for a partnership.

IFRS Joint Venture Accounting -- Accounting at Formation Example

Example: Facts: Jay, Inc. and Vee, Inc. enter into an agreement to establish JV, Inc., a jointly controlled entity. Each investor will own a 50% interest in the venture and will contribute cash and land or equipment to the venture. Jay contributes $50,000 cash and land with a carrying value of $25,000 and a fair value of $30,000. Jay Entry: DR: Investment in JV, Inc. Joint Venture $77,500 CR:Cash $50,000 CR:Land (Carrying Value) 25,000 CR:Gain (FV $30,000 - CV $25,000 = $5,000 x .50) 2,500 Exception to Gain/Loss Recognition: Partial recognition of gains/losses on non-monetary assets contributed to a joint venture (jointly controlled entity) would not be made when: 1) The significant risks and rewards of the asset have not been transferred to the jointly controlled entity, or 2) The gain/loss on the asset cannot be measured reliably.

FRS Accounting Subsequent to Formation

IFRS permits two alternative methods of accounting for a jointly controlled entity: a. Equity Method -- This method follows the conventional equity method (i.e., a one-line consolidation). b. Proportionate Consolidation Method -- Under this method, the investor recognizes in its financial statements it share of the assets, liabilities, revenues (income) and expenses of the joint venture. These items and amounts may be recognized in one of two ways: i. Combined on a line-by-line basis with similar items in the investor's financial statements. ii. Reported as separate line items in the investor's financial statements; for example, separate line items for "Plant and Equipment" (of the investor) and "Interest in Plant and Equipment of Jointly Controlled Entity" (of the joint venture). c. Whether the equity method or the proportional consolidation method is used, the method selected must be applied on a consistent basis. d. IFRS does not require proportionate consolidation or the equity method to be applied when an interest in a joint venture is acquired and held with a view to disposal within twelve months of acquisition.

Corporate Joint Ventures -- variable interest entity

If the joint venture is determined to be a variable interest entity and the investor determines that it is the primary beneficiary, the investor will consolidate the joint venture (because, as the primary beneficiary, it has effective control even though it does not hold a controlling equity interest).

Corporate Joint Ventures -- Not VIE

If the joint venture is not a variable interest entity (or the investor is not the primary beneficiary, if it is a VIE), the investor accounts for and reports its investment in the corporate joint venture using the equity method of accounting (because, generally, all investors in a joint venture can exercise at least significant influence). If, in a rare case, a single investor is able to unilaterally control a corporate joint venture that is not a VIE, that controlling investor would consolidate the joint venture.

Joint Venture Accounting Introduction

Introduction -- Formal accounting for investments in joint ventures is specified only for corporate joint ventures - a joint venture organized as a separate corporation with the parties to the joint venture owning the equity of the separate corporation. The equity of the separately established corporation is not traded in any market, and certainly does not have a ready market.

Which, if either, of the following statements concerning the accounting for a joint venture under U.S. GAAP and IFRS is/are correct? I. Under U.S. GAAP, a joint venture can be either a corporation or a partnership; under IFRS a joint venture can be only a company (corporation). II. Under both U.S. GAAP and IFRS, a gain or loss on the contribution of a nonmonetary asset to a joint venture can be recognized.

Neither Statement I nor Statement II is correct. While it is correct that, under U.S. GAAP a joint venture can be either a corporation or a partnership, it also is true that under IFRS a joint venture can be either a company/corporation or a partnership (Statement I). Further, only under IFRS can a gain or loss on the contribution of a nonmonetary asset to a joint venture be recognized (Statement II).

Partnership Joint Venture

Partnership Joint Venture -- When the joint venture is formed as a partnership, accounting by the investor/partner for contributions to form the joint venture would be the same as for a corporation, except that it would be recorded as Investment in JV Partnership, Joint Venture.

Partnership Joint Ventures

Partnership Joint Ventures -- An investor/partner in a joint venture in the form of a partnership would account for its investment as would any partner, with adjustments (equity method-like) for any intercompany items. a. Any intercompany profits/losses included in the assets resulting from transactions between the investor/partner and the partnership would be eliminated. b. The investment account of the investor would be increased (decreased) for the investor's share of joint venture profits (losses), after eliminating intercompany items, if any. c. The investment account of the investor would be decreased for distributions received from the partnership joint venture.

Which one of the following is least likely to be used to report an investment in a corporate joint venture?

The fair value method is least likely to be used to report an investment in a corporate joint venture. Even though an investment in a joint venture is a financial asset, and financial assets generally are eligible to be reported at fair value at the election of the holder (investor), such an option is not likely to be available for joint ventures because (1) if the joint venture is to be consolidated, it is not eligible for fair value measurement and (2) even if it is not to be consolidated, the nature of joint ventures (e.g., not traded in a public market) makes it unlikely that a readily determinable fair value will be available.

U.S. entities, Joco, Inc. and Vico, Inc., formed a corporate joint venture, JoViCo, Inc., with each holding a 50% ownership interest. Joco contributed $100,000 cash and equipment that had an original cost of $50,000, accumulated depreciation of $5,000, and a fair value of $48,000. At which one of the following amounts will Joco record its investment in the JoViCo joint venture?

The investment of the equipment should be recorded at its carrying value ($50,000-$5,000 = $45,000). Therefore, the total investment should be recorded at $100,000 cash + $45,000 equipment = $145,000.

Under IFRS, which of the following methods can be used to account for an investment in a corporate joint venture?

Under IFRS, an investor can account for its investment in a corporate joint venture using either the equity method or proportional consolidation. Under U.S. GAAP, the equity method, full consolidation or partnership accounting, can be used, but not proportional consolidation.