Joint Ventures (JV)
What are Joint Ventures?
A joint venture (JV) is a contractual arrangement between two or more parties to set up a business venture. Many joint ventures are 50:50 ventures where each party owns a 50% share. In such an arrangement, there is an agreement between the parties establishing joint control of the newly formed entity. Joint control exists only when the strategic, financial, and operating decisions relating to the activity require the unanimous consent of the owners.
Key Learning Points
- A joint venture is an arrangement between two or more parties to set up a business venture and jointly share control over it. Companies may enter joint ventures for strategic reasons such as business expansion or cost management
- Many joint ventures follow a 50:50 split where each party contributes equally to the venture and has an equal share in the risks and rewards. Neither party has a controlling stake in the JV.
- Joint ventures are accounted for using equity method accounting, where the investor includes the investment in one line of the income statement, cash flow statement and balance sheet respectively
- Equity method accounting is different from full consolidation where the financials of the subsidiary are fully consolidated in the parent’s financial statement
Joint Ventures Explained
When companies decide to form a joint venture, a key decision is to determine the level of ownership and control of each party in the venture. The choice of each party holding a 50% stake is often a default option. It means both parties make equal cash and non-cash contributions to the venture at the formation stage and neither party has to cede control. The risks and rewards are shared equally between both parties. At times, the choice of a 50:50 split could also be driven by regulations requiring local partners to hold at least a 50% stake in a venture. There could be exceptions where one partner could have a controlling stake in a joint venture.
Joint Ventures: Accounting Methodology
Typically, companies with a 20%-50% stake in a joint venture utilize equity method accounting to account for such investments.
Under this method, the investor includes the profits of the investee as a single line in its income statement, reflecting the investor’s share of the investee’s net income. The investor also shows dividends received from the investee as a single line in its cash flow statement.
The investor includes the investment as a single line in its balance sheet, reflecting the original cost of the investment adjusted for the investor’s share of profits net of dividends received.
Finding Joint Ventures in Financial Statements
Below is an extract from the 2019 annual report of Shell.
There are various transactions related to joint ventures shown in a company’s financial statements, such as investing in a joint venture, the net income or profit from such investments, receiving dividends, and selling off stakes. These transactions are recorded in many places within a company’s financial statements.
Income Statement
The company has reported its share of profit joint ventures and associates in its consolidated statement of income. Note that this is a profit figure, net of expenses incurred by the joint venture, but it is shown beneath Shell’s own revenue figure and included within the group’s ‘Total revenue and other income’.
Royal Dutch Shell Plc – 20-F, 2019
Balance Sheet
Equity method investments such as joint ventures and associates are reported in the company’s balance sheet under non-current assets.
Royal Dutch Shell Plc – 20-F, 2019
Statement of Cash Flows
Royal Dutch Shell Plc – 20-F, 2019
The company has shown many transactions related to joint ventures in its cash flow statement. For example, they have deducted the investments in, and added proceeds from the sale of, joint ventures and associates to arrive at the cash flow from investing activities.
Notes to Consolidated Financial Statements
The company has included the details of its income from joint ventures and associates in a separate note (note 9) within the notes to consolidated financial statements. The notes also include the or the net book value of these investments.
Example: Joint Ventures
Here is some information about two companies, Ajaccio and Bonifacio. Ajaccio has a 50.0% stake in Bonifacio, which is reported as a joint venture in the latest financial reports, as follows:
Bonifacio is forecasting to generate net income of 61,390.0 next year and is expecting to pay a dividend of 5,000.0.
We have been asked to determine what will Ajaccio report in its financial statements next year, given these numbers from Bonifacio.
Ajaccio reports 50% of Bonifacio’s income in its financial statements as equity income since that is their investment in the company. Likewise, Ajaccio is entitled to 50% of dividends from the joint venture and will report it accordingly in its cash flow statements. The amount in the balance sheet will be updated to reflect the net income Ajaccio has earned from its investment in Bonifacio, adding value to that investment, less the dividend received from Bonifacio, which will reduce the value of the Ajaccio’s investment.
The dividend accounting may appear confusing as many people want to put the dividends in the income statement. However, the income statement takes account of all of the income that has been earned from the investment in the joint venture on an accruals basis, whether that income has been paid out to the investor or not. The dividend payment is then accounted for by reducing the value of the investment in the joint venture and increasing cash, essentially transferring the value between two asset balances on the investing company’s balance sheet.