The proportional consolidation method is a technique in accounting used for consolidating joint ventures. It is an essential topic for accounting students to grasp as it reflects how an entity accounts for its share in joint ventures where it has significant control or influence but does not have full control. The method essentially combines the financial statements of the venturer (the parent company) with its proportional share of the joint venture’s financial results.
In this tutorial, we will explore the proportional consolidation method in depth, illustrating its application through real-world examples. We’ll cover the theory, journal entries, and financial statement effects of proportional consolidation to help you understand how to apply this method in practice.
What is Proportional Consolidation?
Proportional consolidation refers to a method of consolidating a joint venture’s financial statements, where the venturer includes its proportionate share of the joint venture’s assets, liabilities, income, and expenses in its consolidated financial statements. This method differs from the full consolidation method, where the parent consolidates 100% of the subsidiary’s financials, even if it does not own 100% of the subsidiary.
The proportional consolidation method is typically used when an entity has joint control of a venture but does not control it fully. Joint control means that no single party has control over the venture, but decisions require the consent of more than one party.
Under this method, the venturer recognizes only its proportionate share of the assets, liabilities, income, and expenses, which reflects the partial interest held in the joint venture.
When to Use Proportional Consolidation?
Proportional consolidation is generally used in joint ventures that meet the following conditions:
- The entity has joint control, meaning it shares control over the venture with other parties.
- The entity has significant influence over the joint venture but does not have the ability to control it independently.
- The joint venture is not structured in a way that would allow the venturer to use full consolidation.
This method is not widely used today under modern accounting standards, such as IFRS and GAAP, as these standards now prefer the equity method for joint ventures. However, the proportional consolidation method is still useful for educational purposes and is occasionally used in certain jurisdictions.
How Does Proportional Consolidation Work?
Let’s now explore how proportional consolidation works by applying the method step-by-step through a practical example.
Example 1: Overview of the Joint Venture
Consider two companies, Company A and Company B, which have entered into a joint venture called “AB Joint Venture.” The venture was formed with equal ownership (50%) by both companies. The joint venture has the following financial results for the year:
- Assets: $200,000
- Liabilities: $80,000
- Revenues: $150,000
- Expenses: $100,000
Since both Company A and Company B own 50% each of the joint venture, they will each consolidate 50% of the joint venture’s financial results into their own statements using the proportional consolidation method.
Step 1: Consolidating Assets
Each company will recognize 50% of the joint venture’s assets on its balance sheet. So, for Company A, the consolidated balance sheet will include:
- 50% of $200,000 in assets = $100,000
Step 2: Consolidating Liabilities
Similarly, Company A will recognize 50% of the joint venture’s liabilities:
- 50% of $80,000 in liabilities = $40,000
Step 3: Consolidating Revenue
Company A will also include 50% of the joint venture’s revenues:
- 50% of $150,000 in revenue = $75,000
Step 4: Consolidating Expenses
Lastly, Company A will include 50% of the joint venture’s expenses:
- 50% of $100,000 in expenses = $50,000
Journal Entries for Proportional Consolidation
Let’s now look at how these figures translate into journal entries under the proportional consolidation method. Assume the following journal entries are recorded by Company A to reflect its 50% share of the joint venture’s results.
Journal Entries for Consolidating Assets and Liabilities
Company A will record the following journal entries to recognize its 50% share of the joint venture’s assets and liabilities:
Journal Entry 1: Recording Assets
| Account | Debit | Credit |
|---|---|---|
| Investment in Joint Venture | $100,000 | |
| Cash/Bank | $100,000 |
Journal Entry 2: Recording Liabilities
| Account | Debit | Credit |
|---|---|---|
| Liabilities of Joint Venture | $40,000 | |
| Cash/Bank | $40,000 |
Journal Entries for Recognizing Revenue and Expenses
Next, Company A will record its share of the joint venture’s revenue and expenses.
Journal Entry 3: Recognizing Revenue
| Account | Debit | Credit |
|---|---|---|
| Revenue from Joint Venture | $75,000 | |
| Cash/Bank | $75,000 |
Journal Entry 4: Recognizing Expenses
| Account | Debit | Credit |
|---|---|---|
| Expenses of Joint Venture | $50,000 | |
| Cash/Bank | $50,000 |
Proportional Consolidation in the Financial Statements
After recording these journal entries, Company A’s financial statements will reflect the proportional consolidation of the joint venture’s financial results.
Consolidated Balance Sheet for Company A
| Account | Amount |
|---|---|
| Assets | |
| Investment in Joint Venture | $100,000 |
| Liabilities | |
| Liabilities of Joint Venture | $40,000 |
| Equity | |
| Equity of Company A | $60,000 |
Consolidated Income Statement for Company A
| Account | Amount |
|---|---|
| Revenue | |
| Revenue from Joint Venture | $75,000 |
| Expenses | |
| Expenses of Joint Venture | $50,000 |
| Net Income | $25,000 |
Practice Questions
To help solidify your understanding of proportional consolidation, here are three practice questions based on the example above. Afterward, we’ll go through the solutions to ensure you’ve grasped the key concepts.
Question 1:
If Company B is the venturer and has a 60% share in the joint venture instead of 50%, how would the journal entries change?
Question 2:
What is the impact on the financial statements of Company A if the joint venture incurs a loss of $20,000 instead of the $50,000 profit used in the example?
Question 3:
If Company A’s share in the joint venture is 30%, how would the consolidation entries change?
Answers Section
Answer 1: If Company B has a 60% share in the joint venture, the journal entries for Company B would be as follows:
- Assets: 60% of the joint venture’s assets = 60% of $200,000 = $120,000
- Liabilities: 60% of the joint venture’s liabilities = 60% of $80,000 = $48,000
- Revenue: 60% of the joint venture’s revenue = 60% of $150,000 = $90,000
- Expenses: 60% of the joint venture’s expenses = 60% of $100,000 = $60,000
Thus, Company B’s journal entries would reflect a 60% consolidation share.
Answer 2: If the joint venture incurs a loss of $20,000 instead of a profit, Company A’s share of the loss (50%) would be $10,000. This would reduce Company A’s consolidated revenue and increase its consolidated expenses, impacting the net income.
Answer 3: If Company A’s share in the joint venture is 30%, the entries would change as follows:
- Assets: 30% of $200,000 = $60,000
- Liabilities: 30% of $80,000 = $24,000
- Revenue: 30% of $150,000 = $45,000
- Expenses: 30% of $100,000 = $30,000
This would adjust Company A’s journal entries and financial statements accordingly, reflecting the 30% share of the joint venture’s results.
Conclusion
The proportional consolidation method is an important concept for accounting students to master, especially in understanding how joint ventures are accounted for in the financial statements. This method requires venturers to combine their share of the joint venture’s assets, liabilities, income, and expenses with their own, reflecting the partial control they have in the venture.
By working through these examples and practice questions, you should now have a clear understanding of how proportional consolidation works and how to apply it in real-world accounting scenarios.