Chapter 8 Interests In Joint Ventures

© 2009 Clarence Byrd Inc. 2 Joint Venture Defined  Paragraph (c) A joint venture is an economic activity resulting from a contractual arrangement whereby two or more venturers jointly control the economic activity.

© 2009 Clarence Byrd Inc. 3 Other Terminology  Paragraph (b)  Paragraph (b) Joint control of an economic activity is the contractually agreed sharing of the continuing power to determine its strategic operating, investing and financing policies.  Paragraph (e)  Paragraph (e) A venturer is a party to a joint venture, has joint control over that joint venture, has the right and ability to obtain future economic benefits from the resources of the joint venture and is exposed to the related risks.

© 2009 Clarence Byrd Inc. 4 Forms of Organization  Jointly Controlled Operations  Uses assets or other resources of individual venturers  Does not involve the formation of a separate enterprise

© 2008 Clarence Byrd Inc. 5 Forms of Organization  Jointly Controlled Assets  Joint ownership or control of one or more assets  Does not involve the formation of a separate enterprise

© 2009 Clarence Byrd Inc. 6 Forms of Organization  Jointly Controlled Enterprise  Involves separate corporation or partnership  The separate enterprise owns or controls the assets

© 2009 Clarence Byrd Inc. 7 Classification Example A Owns 60%B Owns 20%C Owns 15%D Owns 5% Joint Venture

© 2009 Clarence Byrd Inc. 8 Classification Example  If No Agreement  A classifies as subsidiary  B classifies as significantly influenced (probably)  C and D classify as available for sale or held for trading

© 2009 Clarence Byrd Inc. 9 Classification Example Agreement A and D do not participate in management. B and C have joint control B and C would classify as joint venture A and D would classify as available for sale or held for trading

© 2009 Clarence Byrd Inc. 10 Accounting Methods  Paragraph Interests in joint ventures should be recognized in the financial statements of the venturer using the proportionate consolidation method. (January, 1995)

© 2009 Clarence Byrd Inc. 11 Accounting Methods  IAS No. 31 allows the use of either proportionate consolidation or the equity method

© 2009 Clarence Byrd Inc. 12 Accounting Methods The Future It is likely that Proportionate Consolidation will be eliminated, with the equity method required

© 2009 Clarence Byrd Inc. 13 Cessation Of Joint Control Joint Control Unilateral Control – Section 1590 Subsidiaries Loss of Participation – Section 3051 or 3855 Discontinued Operations - Section 3475

© 2009 Clarence Byrd Inc. 14 Differential Reporting  Paragraph  Paragraph An enterprise that qualifies under “Differential Reporting”, Section 1300, may elect to use either the equity method or the cost method to account for its interests in joint ventures that would otherwise be accounted for using the proportionate consolidation method in accordance with paragraph All interests in joint ventures should be accounted for using the same method. (January, 2002)

© 2009 Clarence Byrd Inc. 15 Differential Reporting  Paragraph  Paragraph A loss in value of an interest in a joint venture not proportionately consolidated that is other than a temporary decline should be accounted for in accordance with the requirements of “Investments”, Paragraphs (October, 2006)

© 2009 Clarence Byrd Inc. 16 Differential Reporting  Paragraph  Paragraph Interests in joint ventures not proportionately consolidated should be presented separately in the balance sheet. Income or loss from those interests should be presented separately in the income statement. (January, 2002)  Paragraph  Paragraph An enterprise that has applied one of the alternative methods permitted by paragraph should disclose the basis used to account for interests in joint ventures. (January, 2002)

© 2009 Clarence Byrd Inc. 17 Non-Cash Capital Contributions  Influenced by several Handbook sections  3831 – Non-Monetary Transactions  3840 – Related Party Transactions  3063 – Impairment Of Long-Lived Assets  3064 – Goodwill and Other Intangible Assets

© 2009 Clarence Byrd Inc. 18 Losses On Non-Monetary Capital Contributions  Paragraph When a venturer transfers assets to a joint venture and receives in exchange an interest in the joint venture, any loss that occurs should be charged to income at the time of the transfer to the extent of the interests of the other non-related venturers. When such a transaction provides evidence of a decline that is other than temporary in the carrying amount of the relevant assets, the venturer should recognize this decline by writing down that portion of the assets retained through its interest in the joint venture. (January, 1995)

© 2009 Clarence Byrd Inc. 19 Losses On Non-Monetary Capital Contributions A venturer has land with a current fair market value of $450,000 and an original cost of $600,000. The venturer transfers this land to a joint venture in return for a 1/3 interest in the enterprise.

© 2009 Clarence Byrd Inc. 20 Losses On Non-Monetary Capital Contributions  Minimum loss of $100,000 [(2/3)($600,000 - $450,000)] must be recognized and charged to income  If transfer provides evidence of non- temporary decline in value, would recognize and charge to income the remaining $50,000

© 2009 Clarence Byrd Inc. 21 Gains On Non-Monetary Capital Contributions  Paragraph  Paragraph When a venturer transfers assets to a joint venture and receives in exchange an interest in the joint venture, any gain that occurs should be recognized in the financial statements of the venturer only to the extent of the interests of the other non-related venturers, and accounted for in accordance with paragraphs and (January, 1995)

© 2009 Clarence Byrd Inc. 22 Gains On Non-Monetary Capital Contributions A venturer has land with a current fair market value of $700,000 and an original cost of $500,000. The venturer transfers this land to a joint venture in return for a 40 percent interest in the enterprise.

© 2009 Clarence Byrd Inc. 23 Gains On Non-Monetary Capital Contributions  Can recognize gain of $120,000 [(60%)($700,000 - $500,000)]  Would not be included in income unless the contributor received some cash

© 2009 Clarence Byrd Inc. 24 Gains On Non-Monetary Capital Contributions Required Journal Entry Investment In Joint Venture$620,000 Deferred Gain$120,000 Land500,000 Note: None of the recognized gain is taken into income

© 2009 Clarence Byrd Inc. 25 Gains On Non-Monetary Capital Contributions  Gains can only be taken into income to the extent that the venturer receives cash or other assets that do not represent an equity interest in the venture  Income inclusion based on the ratio of the cash received to the fair value of the asset

© 2009 Clarence Byrd Inc. 26 Gains On Non-Monetary Capital Contributions A venturer has land with a current fair market value of $800,000 and an original cost of $500,000. The venturer transfers this land to a joint venture in return for a 40 percent interest in the enterprise, plus cash of $100,000.

© 2009 Clarence Byrd Inc. 27 Gains On Non-Monetary Capital Contributions  Can recognize a gain of $180,000 [(60%)($800,000 - $500,000)]  Can take $37,500 into income

© 2009 Clarence Byrd Inc. 28 Gains On Non-Monetary Capital Contributions Required Journal Entry Investment In Joint Venture$580,000 Cash100,000 Income Gain$ 37,500 Deferred Gain ($180,000 - $37,500)142,500 Land500,000 The value for the investment equals the $500,000 carrying value of the Land, plus the recognized gain of $180,000, less the cash of $100,000.

© 2009 Clarence Byrd Inc. 29 Gains On Non-Monetary Capital Contributions  If cash paid to contributor involves bank financing:  Venturer’s share of financing removed from consideration received  Reduces the amount of gain that can be included in income

© 2009 Clarence Byrd Inc. 30 Intercompany Transactions  If investee is a subsidiary:  Eliminate the expense, the revenue, and the profit  Investor and investee are one entity An investee sells merchandise to an investor for $40,000. As the merchandise cost $25,000 there is a profit of $15,000.

© 2009 Clarence Byrd Inc. 31 Intercompany Transactions  If investee is significantly influenced:  Leave the expense and revenue  Eliminate the profit  Investor and investee are separate but not arm’s length An investee sells merchandise to an investor for $40,000. As the merchandise cost $25,000 there is a profit of $15,000.

© 2009 Clarence Byrd Inc. 32 Intercompany Transactions  If investee is a joint venture and investor is arm’s length with other venturers  Only the investor’s share of expenses, revenues, and profits is eliminated An investee sells merchandise to an investor for $40,000. As the merchandise cost $25,000 there is a profit of $15,000.

© 2009 Clarence Byrd Inc. 33 Downstream Transactions  Paragraph When a venturer sells assets to a joint venture in the normal course of operations and a gain or loss occurs, the venturer should recognize the gain or loss in income to the extent of the interests of the other non-related venturers. When such a transaction provides evidence of a reduction in the net realizable value, or a decline in the value, of the relevant assets, the venturer should recognize the full amount of any loss in income. (January, 1995)

© 2009 Clarence Byrd Inc. 34 Downstream Transactions Example Dondor has a 40 percent interest in Dondee, a joint venture. During the year Donder sells merchandise with a cost of $20,000 to Dondee for $28,000.

© 2009 Clarence Byrd Inc. 35 Downstream Transactions Required Elimination Entry Sales [(40%)($28,000)] $11,200 Inventory [(40%)($28,000 - $20,000)] $3,200 Cost Of Sales [(40%)($20,000)] 8,000 This leaves the other venturers’ share of the $8,000 profit in the proportionate consolidation Income Statement.

© 2009 Clarence Byrd Inc. 36 Upstream Transactions  Paragraph When a venturer purchases assets from a joint venture in the normal course of operations, the venturer should not recognize its share of the profit or loss of the joint venture on the transaction until the assets are sold to a third party. However, when the transaction provides evidence of a reduction in the net realizable value, or a decline in the value of the relevant assets, the venturer should recognize its share of the loss in income immediately. (January, 1995)

© 2009 Clarence Byrd Inc. 37 Upstream Transactions Example Dondor has a 40 percent interest in Dondee, a joint venture. During the year Dondee sells merchandise with a cost of $20,000 to Dondor for $28,000.

© 2009 Clarence Byrd Inc. 38 Upstream Transactions Required Elimination Entry Sales [(40%)($28,000)] $11,200 Inventory [(40%)($28,000 - $20,000)] $3,200 Cost Of Sales [(40%)($20,000)] 8,000 This is the same entry required in the case of downstream transactions. However, as this is an upstream transaction, a further entry would be required to eliminate the other 60 percent because of the application of proportionate consolidation procedures. This would be part of the investment elimination.

© 2009 Clarence Byrd Inc. 39 Disclosure  Paragraph A venturer should disclose the total amounts and the major components of each of the following related to its interests in joint ventures:  (a) current assets and long-term assets;  (b) current liabilities and long-term liabilities;  (c) revenues, expenses and net income;  (d) cash flows resulting from operating activities;  (e) cash flows resulting from financing activities; and  (f) cash flows resulting from investing activities. (January, 1995 )

© 2009 Clarence Byrd Inc. 40 Disclosure  Paragraph A venturer should disclose its share of any contingencies and commitments of joint ventures and those contingencies that exist when the venturer is contingently liable for the liabilities of the other venturers of the joint ventures. (January, 1995)

© 2009 Clarence Byrd Inc. 41 International Convergence  IAS No. 31 – Interests In Joint Ventures

© 2009 Clarence Byrd Inc. 42 IAS No. 31  Scope  Excludes venture capital organizations  Excludes mutual funds, unit trusts, and investment linked insurance funds

© 2009 Clarence Byrd Inc. 43 IAS No. 31  Accounting Method  Current IAS No. 31 allows either equity method or proportionate consolidation  Proposed changes would eliminate the use of proportionate consolidation (IFRS Exposure draft)  U.S. standards do not allow use of proportionate consolidation

© 2009 Clarence Byrd Inc. 44 IAS No. 31  Intercompany Transactions  IAS No. 31 does not distinguish between capital contributions and other intercompany transactions.  Rules are similar except IAS No. 31 does not limit the amount of gain to be taken into income on capital contributions

© 2009 Clarence Byrd Inc. 45