Living SAP Joint venture accounting (JVA) – Part 1

The simple definition of  joint venture (JV) is a business arrangement where two or more parties pool their resources for the purpose of accomplishing a specific task.*

* According to investopedia https://www.investopedia.com/terms/j/jointventure.asp

In fact this straightforward clear definition, doesn’t give from my point of view the flavour of Joint venture accounting.

That’s why in this blog I invite you to live JVA through this (interactive) blog

Let’s have some imagination:

You and your friend(s) having a drink and discussing opening a new business this business or industry considered high risk, demanding extensive capital investment and a has long payback period.you decide to minimize this risk by creating partnership

  • This is exactly what Joint venture does, creating partnership to minimize risk(s)

As a partner what are the questions about partnership that you are going to ask ?

  • Take two mins to think about the above question. If your question not part of following questions please add it in comments

The main commonly asked questions:

1.What is the business type ? What is the product?

2.Who will be the operator ? What will be my role?

3.How to record our agreement and ownership shares?

4.How to record or extend agreement activities ?

5.How and when cash will be collected from partners?

6.How / When expenses and revenues will be divided?

7.Which overhead costs to be divided?

8.What if I need to change equity or Exit?

9.What if a new partner wants to Join?

10. How to handle disputes?

Let’s handle first question:

1.What is the business type ? What is the product?

When partnership is needed this means this business most probably has one or more of  the following characteristics:

  1. Long payback period
  2. High risk
  3. Long term commitment
  4. High Investment

Perfect example of industries that have the above characteristics is Upstream Oil and Gas industry,

If we look to oil and gas industry it consist of three streams:

Oil and Gas Upstream process takes in average 4 years to produce crude oil according to American progress organization * & from 5 to 10 years depending on the size of project according to Canada’s Upstream Oil & Natural Gas Industry **

With average cost of installing offshore rigs is 650 M. according to interesting engineering website ***

That’s why it’s considered the perfect example for high risk,high investment, long term commitment with long payback industry

* https://www.americanprogress.org/article/5-reasons-why-the-united-states-cant-drill-its-way-to-energy-independence/
** https://www.capp.ca/oil/extraction/
*** https://interestingengineering.com/science/the-engineering-and-construction-of-offshore-oil-platforms

After answering what industry types the we use JVA with it, Let’s go to the next one

2.Who will be the operator ? What will be my role?

Depending on your role in the Joint venture, you have different activities.

In Joint venture there is one operator in partnership with one or more non-operators

The operator

  • Manage the venture on a day-to-day basis
  • Maintain venture accounting records
  • Calculate partner shares of venture expenditure and revenue
  • Report venture activity to partners

Non-Operating Partner

  • Maintain accounting records for their own share of the venture
  • Settle accounts with the operating partner, according to the conditions of the venture

With knowing your role in the venture we are setting the basic concept between you and your partners.

Let’s start the formalization process by answering the third question.

3.How to record our agreement and ownership shares?

Joint operating agreement is highest level of JVA structure, assigned to company code, and it represents the formal contractual agreement which:

  • Specifies conditions for joint activities
  • Defines partner shares (working interests)
  • Describes rules for sharing profit and loss
  • Specifies penalties

In the creation of  Joint operating agreement, Partners defined as Equity groups (EGP) which contain both operator and non-operators and their shares determined as part of  JOA agreement.

Transaction GJAA:

Summary:

Now, we could cover three questions from main questions that being asked when we start JVA partnership

1.What is the business type ? What is the product?

2.Who will be the operator ? What will be my role?

3.How to record our agreement and ownership shares?

In the next blog, we should continue answering common partnership questions that being covered by JVA.