Decision Usefulness of Alternative Joint Venture Reporting Methods

Article excerpt

SYNOPSIS: Depending on the country and circumstances, reporting rules for intercorporate investments may require the cost method, the equity method, proportionate consolidation, or full consolidation, and may yield dramatically different accounting numbers. In the post-Enron environment there is a particular focus on investments for which liabilities remain off balance sheet. We compare the information content of alternative accounting treatments for a sample of Canadian firms reporting joint ventures under proportionate consolidation. We restate their financial statements using the equity method, and we compare the information content of the two accounting methods in predicting accounting return on common shareholders' equity. We find evidence consistent with the view that financial statements prepared under proportionate consolidation provide better predictions of future return on shareholders' equity than do financial statements prepared under the equity method. We conclude that, for these firms, proportionate consolidation provides information with greater predictive ability and greater relevance than does the equity method.

INTRODUCTION

Intercorporate investments in the form of joint ventures have increased considerably over the past 20 years. Firms in many industries partner to share risks, to share capital costs, and to generate synergy between companies. Examples include process technologies, production capacity, distribution networks, and access to raw materials. In particular, international joint ventures represent an increasingly attractive way to expand into foreign markets while minimizing political and economic risks like expropriation and currency shocks inherent in international business activities (Goldberg and Wolf 1993; Freedman 1996). The prescribed accounting treatment for joint ventures varies across nations, with two principal alternatives in wide use: (1) the equity method, required in some or all situations in the United States, the United Kingdom, Australia, and New Zealand; and (2) proportionate consolidation, required in Canada and preferred by International Accounting Standards (1AS No. 31) and continental countries in the European Union.

This study provides evidence relevant to the decision-usefulness of joint venture accounting by analyzing joint venture reporting of Canadian firms over the period 1995-2001. Specifically, we compare the predictive ability of venturer financial statements prepared under proportionate consolidation (reported) with financial statements prepared under the equity method (restated). The Financial Accounting Standards Board's (FASB 1990) Conceptual Framework identifies predictive value as a characteristic of relevance that, along with reliability, makes information useful for economic decisions. Our results indicate that financial statements for firms with joint ventures prepared under proportionate consolidation provide better predictions of future profitability than under the equity method.

While joint ventures are one type of intercorporate investment whose use is growing, the underlying accounting issues are common to other investment types currently reported under the cost, equity, or consolidation methods. Hence, in addition to providing evidence on the predictive ability of alternative accounting methods for joint ventures, this study suggests the importance of research on alternative accounting methods for other types of intercorporate investments.

ACCOUNTING FOR INTERESTS IN JOINT VENTURES

Accounting for interests in joint ventures varies, as many countries require the equity method, at least in some circumstances. Under the equity method, the venturer's net investment in the joint venture is shown as a single line item on the venturer's balance sheet. Similarly, the venturer's share of the joint venture's net income or loss appears as a single line item on the venturer's income statement. In Canada, the equity method is not acceptable and proportionate consolidation is required. …