Proportionate Consolidation vs. the Equity Method: A Decision Usefulness Perspective on Reporting Interests in Joint Ventures

Abstract

The number of joint ventures, and the number of industries in which joint ventures are commonplace, have expanded considerably over the past twenty years. The prescribed treatment for accounting for interests in joint ventures varies across nations, with some requiring the equity method (e. g., the United States) and some requiring proportionate consolidation (e. g., Canada). A 1999 report by the G4+1 recommends that venturers use the equity method to account for interests in joint ventures, but cautions that there is very little empirical evidence on the decision usefulness of one approach over the other. This paper provides empirical evidence on this question by analyzing the financial statements of Canadian firms reporting joint ventures over the period 1995-2000. Our results show that ratios calculated from proportionately consolidated venturer financial statements are more useful in predicting one-, two- and three-year-ahead return on common shareholders' equity than are ratios calculated from venturer financial statements prepared under the equity method. We conclude that, at least for this set of firms, proportionate consolidation provides information with greater predictive ability and, therefore, greater relevance to financial statement users than does the equity method.

Keywords: joint venture, standard-setting, equity method, proportionate consolidation, Canada, US, financial accounting, relevance, predictive ability

JEL Classification: M41, M44, G12