Question 15.7: Joint Venture Assume that hypothetical Companies A and B ent...
Joint Venture
Assume that hypothetical Companies A and B enter into a joint venture, each with a 50 percent interest. The first column presents the assumed financial statement for the joint venture in its first year. Columns 2 and 3 reflect the financial result for Company A under the two methods of accounting for its interest in the joint venture.
^aThe data (other than the subtotals) shown under the equity method are the same as if there had been no joint venture except for “Equity in joint venture income,” “Investment in joint venture,” and “Retained earnings.”
| Company A Venturer | |||
| Joint Venture | Equity Method^a | Proportionate Consolidation | |
| Income Statement | |||
| Sales | $400,000 | $1,000,000 | $1,200,000 |
| Equity in joint venture income | 60,000 | ||
| Cost of sales | 200,000 | 500,000 | 600,000 |
| Other expenses | \underline{80,000} | \underline{240,000} | \underline{280,000} |
| Net income | $120,000 | $320,000 | $320,000 |
| Balance Sheet | |||
| Cash | $40,000 | $400,000 | $420,000 |
| Inventory | $500,000 | $500,000 | |
| Investment in joint venture | $450,000 | ||
| Other assets | \underline{1,160,000} | \underline{1,500,000} | \underline{2,080,000} |
| $1,200,000 | $2,850,000 | $3,000,000 | |
| Accounts payable | $200,000 | $200,000 | |
| Long-term debt | 300,000 | 1,650,000 | 1,800,000 |
| Capital stock | 600,000 | 600,000 | |
| Retained earnings | \underline{400,000} | \underline{400,000} | |
| Venturers’ (Companies A and B) equity | \underline{900,000} | ||
| $1,200,000 | $2,850,000 | $3,000,000 | |
First, examine the income statement. Notice that net income is $320,000 using either the equity method or proportionate consolidation. But sales, cost of sales, and expenses are different because under the equity method the net effect of sales, cost of sales, and expenses is reflected in the $60,000 equity in joint venture income.
On the balance sheet, the line item investment in joint venture observed under the equity method is replaced by the proportionate share of each balance sheet account in the proportionate consolidation method. The single line item is replaced with a line-by-line consolidation. Because the venturer has a 50 percent interest in the joint venture, 50 percent of joint venture assets and liabilities are included in the proportionate balance sheet.
The analyst will observe differences in performance ratios based on the accounting method used for joint ventures.
| Equity Method | Proportionate Consolidation | |
| Net profit margin | 32.0% | 26.7% |
| Return on assets | 11.2% | 10.7% |
| Debt/Equity | 1.65 | 1.80 |