Joint ventures: alternative methods of accounting*

At the start of year 1, Zeus reports the following balance sheet:

Zeus Company Assets Equities Cash 20 Liabilities 100 Other assets 180 Shareholders’ equity 100 200 200 On that date Zeus enters into a joint venture with Maia. They establish a new firm, Hermes, and each invests cash of 10 in it. Hermes raises debt (on the strength of Zeus’s and Maia’s guarantees) to finance the purchase of fixed assets. When this investment is made, Hermes’s balance sheet looks as follows:

Hermes Company Assets Equities Liabilities 80 Shareholders’ equity:

Cash and Zeus 10 other assets 100 Maia 10 20 100 100 Required

(a) Zeus wants to know how to account for its investment in Hermes. Prepare a balance sheet for Zeus Company at the start of year 1, assuming the investment:

(1) is accounted for by the equity method;

(2) is consolidated on a proportionate basis;

(3) is consolidated on a global basis.

When should Zeus use each of the above methods?

(b) At the end of its first year, Hermes reports revenues of 70 and profit of 10. It pays a dividend of 8. Liabilities of 80 are unchanged. In the same period, Zeus reports revenues of 150 and profit

(from its own activities) of 20. It pays a dividend of 12. Its end-year liabilities are still 100. There are no intercompany transactions between Zeus and Hermes except for the dividend. Ignore taxes.

For each of the methods listed in

(a) above:

(i) calculate Zeus’s total profit for year 1; and

(ii) prepare Zeus’s balance sheet at the end of year 1. (Combine cash and other assets.)

Check figures:

(b) (ii) End-year 1 total assets

(1) 213 (2) 253 (3) 304 AppenedixLO1