blog updates

Follow KSM
Search

KSM blog

KSM Blog | Katz, Sapper & Miller CPA

How Contractors Use Joint Ventures to Land the Big Projects

Posted 12:22 PM by

Accounting for Joint Ventures

The continued growth or success of a construction company may hinge on obtaining a large contract. In some cases, a company may not procure that contract due to bonding constraints, a lack of skilled labor, or simply some other resource or perceived specialty is nonexistent. In these situations, two or more companies could form a joint venture to overcome these limitations and propose on a project.

Contractors can use a joint venture to combine their resources (and bonding capacity). This joint venture may last for one project or continue for other unique projects before being dissolved. In addition to combining resources, a joint venture can be used to spread risk to all venture partners.  

Joint ventures take many forms, both formal and informal. The methods of counting assets, allocating risk, managing ownership and voting rights, and presenting profits and losses are limitless.

Once a joint venture is formed, it needs to be accounted for properly. There are different methods of presenting a company’s interest in a joint venture on their financial statements, including:

  • Historical cost
  • Equity
  • Expanded equity
  • Partial or proportionate consolidation
  • Consolidation method

The most commonly methods used are equity, cost and proportionate consolidation.  

Cost Method

Under the cost method, the original cost of investment is shown as investment in the joint venture on the balance sheet. No adjustment is made to this balance sheet line item for the venture partner’s share of profits or losses. However, dividends received from the joint venture (not in excess of earnings) are recognized as income. Dividends in excess of earnings are a return of capital and should reduce the amount of investment on the balance sheet. This method of accounting is used if a company’s investment in the joint venture is less than 20%.

Equity Method

The most common method of accounting for a joint venture is the equity method. Under the equity method, the investment in the joint venture is reported as a single item on the balance sheet. This amount is adjusted based on shared profits or losses from the inception of the joint venture. The profit or loss from the joint venture is shown on income statements as “Equity Earnings (Loss) From Joint Venture.” This method of accounting is used if a company’s investment in the joint venture is between 20-50%.

Proportionate Consolidation Method

Under the proportionate consolidation method, the company can add its proportionate share in the joint venture’s assets, liabilities, revenues and expenses to its own assets, liabilities, revenues and expenses, respectively. According to FASB ASC 810-10-45, a company may present its investment in a joint venture accounted for by the equity method that has not been incorporated using the proportionate consolidation method.

Alternative Methods Used

A company may also combine the methods described above. A common method that has been used is the presentation of investment in joint venture using equity method on the balance sheet and proportionate consolidation method on the income statement.   

Challenges and Benefits

In addition to accounting complexities, joint ventures pose many other challenges. The joint venture partners will possess unique cultures and management styles. These differences may lead to conflicts and could delay decision making. However, if done right, joint ventures can bolster the growth of a company or could help it to survive in a competitive market.

Generally, joint ventures are formed to solve unusual challenges. They are unique, and should be governed by a well-conceived partnership (or LLC) agreement, considering the potential upside, and downside of the arrangement. It is important to enter into a joint venture with thoughtful due diligence. Choose your partners carefully. Best practice suggests engaging legal, insurance, bonding, finance and accounting professionals for input.  

Zee Malik

About the Author
Zee Malik is a director in Katz, Sapper & Miller’s Construction Services Group. Zee audits and reviews financial statements and advises clients in accounting, reporting, compliance, and internal control matters. Connect with him on LinkedIn.

 

About the Author
Ron Lenz is the partner-in-charge of Katz, Sapper & Miller’s Construction Services Group. Ron's particular areas of expertise include accounting and auditing matters, tax planning and business structuring, mergers and acquisitions, and succession planning. Connect with him on LinkedIn.

link
Comments (0)
Post a Comment
Name:
Email: (Not Displayed)
Website: (optional)
Comment (HTML tags will be stripped):
Please type the alpha-numeric code above (case sensitive):
Error