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Principles of Accounting

Williams Corporation and Jones Company established a joint venture to manufacture components for both companies on January 1, 20X1, and have operated it quite successfully for the past four years. Williams and Jones both contributed 50% of the equity when the joint venture was created. Willams purchases approximately 70% of the output of the joint venture and Jones purchases 30%. Willams and Jones have equal numbers of members on the board of directors of the joint venture and participate equally in the management of the joint venture. Joint venture profits are distributed at year-end on the basis of total purchases by each company.

Willams has been using the equity method to report its investment in the joint venture. However, Willams’s financial vice president believes that each company should use pro-rata consolidation.

As the Controller, you have been asked to prepare a memo discussing those situations in which pro-rata consolidation may be appropriate and to offer your recommendation as to whether Williams should continue to use the equity method or switch to pro-rata consolidation.

Include in your memo citations and quotations from the ASC to support your arguments.

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Sample Answer

 

 

 

Memo

To: Financial Vice President From: Controller Date: October 11, 2024 Subject: Joint Venture Accounting: Equity Method vs. Pro-rata Consolidation

This memo addresses the appropriate accounting method for Williams Corporation’s investment in the joint venture with Jones Company. The current equity method is appropriate based on the information provided.

Full Answer Section

 

 

 

 

Equity Method

The equity method is generally used when an investor has significant influence over an investee but does not have control. According to ASC 810-10-10, significant influence is presumed to exist when an investor owns 20% or more of the voting stock of an investee.

In this case, Williams and Jones each own 50% of the joint venture, clearly indicating significant influence. Therefore, the equity method is the appropriate accounting method.

Pro-rata Consolidation

Pro-rata consolidation is used when a parent company has a controlling interest in a subsidiary. This means that the parent company has the power to direct the policies of the subsidiary.

In the case of Williams and Jones, while they have equal numbers of members on the board of directors and participate equally in management, neither company has a controlling interest. Therefore, pro-rata consolidation is not appropriate.

Conclusion

Based on the information provided, Williams Corporation should continue to use the equity method to account for its investment in the joint venture. The equity method is the appropriate method for joint ventures where neither company has a controlling interest.

Citations

  • ASC 810-10-10: Investments in Subsidiaries. FASB Accounting Standards Codification.

 

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