What is Accounting for Joint Ventures?
Accounting for joint ventures is accounting done when two or more parties or entities combine their resources, within specific conditions or bound by some agreement, for business or transaction purposes. It can be carried out broadly based on whether a separate set of books is kept or not.
- Sharing of Gains and Losses: Accounting methodsAccounting MethodsAccounting methods define the set of rules and procedure that an organization must adhere to while recording the business revenue and expenditure. Cash accounting and accrual accounting are the two significant accounting methods. for the joint ventures, irrespective of the type of arrangement or venture, mainly feature the concept of sharing of incomes and expenditures, gains, and losses.
- Agreement: Joint ventures are always formed on the agreement of collaboration that is binding under most circumstances. The agreement enlists all clauses and aspects regarding the venture.
- Duration of Venture: The agreement most necessarily includes terms on the period for which the businesses have come together for a joint venture. This inclusion is made at the beginning and may be subject to changes on mutual consent.
Types of Accounting for Joint Ventures
Joint Ventures are mainly based on three different characteristics:
#1 – Jointly Controlled Operations
These are Joint ventures, where the two separate entities make use of assets and inventories rather than collaborating them. In such an arrangement, the revenue streamsRevenue StreamsRevenue streams refer to the different sources through which the company generates profit, such as selling the products, catering the services or offering a combination of goods and services to the clients. and expenses incurred are shared by the ventures.
Two businesses can jointly venture by combining their expertise to develop specific products, say software.
#2 – Jointly Controlled Assets
Some joint ventures go on to the extent of collaborating with their assets. The proceedings of the agreement are complex and vary on a case to case basis. The business of the joint venture is recorded as a separate reporting unit, and the corresponding reporting of gains and losses is enlisted.
The oil sector, particularly upstream business, because of the heavy equipment use, has pipelines carrying crude oil or oil mooring systems are some assets that companies share most often. Industries like telecommunications and mining and processing, transport, and logistics departments also share assets.
#3 – Jointly Controlled Entities
In a jointly controlled entity structure, the participating businesses may stretch controlling interestsControlling InterestsA controlling interest is the shareholder's power to speak in the corporate actions or decisions derived from possessing a considerable chunk of the company's voting stock. However, such a stakeholder may or may not hold a significant portion of the company's common stocks. beyond operations, revenues, and assets. The controlling entity may exercise control to the extent that the financial and investing activities of the controlled entity are under the former’s authority.
Telecommunication industry players have ventured into global markets by establishing jointly controlled entities to not only gain control but also make sufficient ground for acquiring regional business insights from a controlled entity.
Accounting for Joint Ventures Journal Entries
Assume that company X provided furniture to company Y worth $10,000. Company Y sold this stock at the same price, with $2,000 incurred in expenses related to transportation and marketing.
Journal entry in the books of company X:
At the same time, company Y will record this in books as:
Methods to Record Joint Ventures Accounting Transactions
Let’s discuss the following methods.
#1 – Equity Method
The equity method comes into the picture when a company has a significant stakeholding in other company or companies. Let’s say that company X has a 50% controlling interest in company Y. If this is the case, then company X will use the equity method to record gains or losses in its financial statementsFinancial StatementsFinancial statements are written reports prepared by a company's management to present the company's financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels. other than its business income. If company Y has annual net earnings of $10 million, then the controlling company X will record $5 million in income in its statements.
#2 – Proportional Consolidation Method
This method is used to record the assets and liabilities of the controlled entity on the financial statements of the controlling entity in the proportion of interest held. Thus, if a company X has a 50% controlling interest in company Y, then we will see company X recording in its statements 50% of assets and liabilities of company Y. Note that it will also record the revenues and expenses of company Y proportionally.
Benefits of Accounting for Joint Ventures
- Joint ventures bring in economies of scale as shared assets, machinery, and expertise help in the capacity ramp-up.
- Economies of scale provide for low-cost production.
- Access to different geographies and newer markets.
- The disadvantage of commonness in objectives and values.
- Joint ventures may restrict flexibility and innovation.
- Unfavorable impacts from the sharing of culture and human resources.
Accounting for Joint Venture is a popular and beneficial method to expand businesses. Businesses that want to tap newer markets and explore geographies tend to rely on a joint venture. It can be successful in any industry but can fail as well. Technology transfer is a significant benefit that can arise out of joint ventures. Accounting in joint venture varies due to global accounting standards and business needs with reliance on equity method more common these days.
This has been a guide to Accounting for Joint Ventures. Here we discuss types and examples of accounting for joint ventures along with its characteristics and detailed explanation. You may learn more about accounting from the following articles –