Proportionate consolidation

Proportionate consolidation – A method of accounting whereby a venturer’s share of each of the assets, liabilities, revenue and expenses of a jointly controlled entity is combined line by line with similar items in the venturer’s financial statements or reported as separate line items in the venturer’s financial statements.

Proportionate Consolidation: Can be utilized under IFRS when there is a joint venture (it is the preferred method under IFRS). The equity method (see below) is also allowed under IFRS. Under US GAAP, equity method should be used.

With proportionate consolidation, you recognize the proportion that you own of the investee in your statements only (i.e., 50% of its revenues, expenses, assets, liabilities…). As you are already accounting for the amount that you own (and not including the proportion that you don’t), there is no need to make a noncontrolling interest adjustment.


Joint venture accounting (JV)

A joint venture (JV) is a contractual arrangement whereby two or more parties (the venturers) agree to share control over an economic activity. The parties do not merge.

Joint ventures may take many different forms and structures:Investments in Joint ventures

  • Jointly controlled operations
  • Jointly controlled assets
  • Jointly controlled entities

A venturer should recognize its interest in a jointly controlled entity using either:

  • Proportionate consolidation, OR
  • Equity accounting

Proportional Consolidation Method of Joint Venture Accounting

Joint ventures are accounted for using equity accounting (same as associates), but also occasionally using proportional consolidation. An illustration of proportional consolidation is presented here.

The example below is an illustration of how a 50% joint venture would be proportionally consolidated into the group accounts. The joint venture is brought into the group accounts on a proportionate line by line basis between sales and net income.

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CU’000

The One Inc.

Joint venture

Proportionate share 50%

Second Plc.

Venturer

Consolidated

Second Plc.

A

B = 50% of A

C

C + B

Sales

8,000

4,000

15,000

19,000

Cost of sales

3,200

1,600

6,000

7,600

Gross margin

4,800

2,400

9,000

11,400

Operating expenses

640

320

1,200

1,520

Operating profit

4,160

2,080

7,800

9,880

Interest

1,664

832

1,560

2,392

Profit before tax

2,496

1,248

6,240

7,488

Tax

-646

-323

-1,640

-1,963

Net income

2,310

1,155

3,200

4,355

Equity Method: Generally used when you own 20 – 50% of a company (and as per above in accounting for joint ventures). However, the 20 – 50% is just a guideline, not a steadfast rule. It is actually whether a company can exert significant influence over the other company (representation on the Board of Directors, participation in the policy-making process, material transactions between the two parties, interchange of managerial personnel or technological dependency).

You recognize the investee on your balance sheet, initially at cost, as an asset (generally as a non-current investment). The investor’s share of the investee’s reported net income, adjusted for certain cost amortizations, shows up as a single line on the income statement. Dividends received are a return on capital and bypass the income statement.

Proportionate consolidation vs equity accounting

The number of joint ventures, and the number of industries in which joint ventures are commonplace, have expanded considerably over the past forty years. The prescribed treatment for accounting for interests in joint ventures varies across nations, with some requiring the equity method (e. g., the United States) and some requiring proportionate consolidation (e. g., Canada). A 1999 report by the G4+1 recommends that venturers use the equity method to account for interests in joint ventures, but cautions that there is very little empirical evidence on the decision usefulness of one approach over the other.

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Research provides empirical evidence on this question by analyzing the financial statements of Canadian firms reporting joint ventures over the period 1995-2000. Our results show that ratios calculated from proportionately consolidated venturer financial statements are more useful in predicting one-, two- and three-year-ahead return on common shareholders’ equity than are ratios calculated from venturer financial statements prepared under the equity method. The conclusion is that, at least for this set of firms, proportionate consolidation provides information with greater predictive ability and, therefore, greater relevance to financial statement users than does the equity method.

Proportionate consolidation

Proportionate consolidation

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