Joint Venture Accounting
Partnerships are often the default type of business when two people or more decide to start a business together. However, research shows that it often results in the failure of the business. Among partnership agreements and other contracts that I have drafted over the years, I believe that there is a more effective solutions to working together while avoiding potential failure due to disagreements.
A joint venture is business contract between individuals that usually involve a long-term or a short-term project. The advantage is that each party in the joint venture can have their own separate business entity. It allows each partner to have more freedom in making decisions that align with their own objectives. Compared to a partnership, a joint venture is more focused on a project. It is a great way to test team work before making a bigger commitment. When people are sharing a business, rather than a specific project, it takes them away from what is important because they tend to focus on small insignificant details.
Joint venture accounting is very similar to a partnership accounting in the sense that partner capital accounts are needed. It is an equity account that keeps track of each partner basis in the venture. That way, they know how much was invested in the venture, how profits are shared, and how much money was withdrawn by each partner.
From each partner perspective, a joint venture is accounted by using the equity method if there is significant influence exercised. Otherwise, the cost method might be used. Considering that the equity method is used, the money invested would be recognized as an investment in joint venture, and it would be reported at cost. Any income or loss both affect the balance sheet and the income statement.
On the balance sheet, the investment is recorded at cost, and any income earned or lost affect the equity account. Keep in mind that losses will decrease the investment account to a zero balance, while profits will continually increase the investment balance. Any dividends reduces the investment account. On the income statement, any profits increase the investment account while showing an increase in investment income.
Whether it may be a good idea to start a joint venture instead of a partnership, the most important is to retain the formula that will help figure out each partner basis in the venture. Initial Investment + Share of Profits – Dividends (Withdrawal) = Ending investment