Proportional Consolidation

What Is Proportional Consolidation?

Proportional consolidation was a former method of accounting for joint ventures under the International Financial Reporting Standards (IFRS) that was abolished by the International Accounting Standards Board (IASB) on Jan. 1, 2013.

It was a method of including income, expenses, assets, and liabilities in proportion to a firm's percentage of participation in a joint venture. Though the proportional consolidation method was previously accepted by the IFRS, it also allowed the use of the equity method.

Under the U.S. generally accepted accounting principles (GAAP), a firm's interest in a joint venture is accounted for using the equity method.

Understanding Proportional Consolidation

A joint venture is when two or more parties share control over an entity or business venture. The parties do not merge into a new entity, and the joint venture is a separate establishment from the other interests of the parties.

A joint venture can be structured in many different ways and can include sharing control over the entire venture, sharing control of operations, sharing control over assets and liabilities, or any other breakdown of shared responsibilities. Overall, however, the parties contribute assets and share risks, enter new markets, expand expertise and technology, and reduce costs.

In reporting their interest in a joint venture, interested parties outside of the U.S. were able to use the equity method or proportional consolidation. Proportional consolidation works by using what is known as a horizontal line-by-line approach to accounting. This displays the parties' share of each individual financial statement item, which is similar to the full consolidation method used for accounting with subsidiaries. In contrast, the equity method uses a vertical one-line consolidation, whereby all the financial statement items are aggregated into one line item on the balance sheet.

Proponents of proportional consolidation argued that this method provided more detailed information since it broke out the performance of the joint venture interest into its individual parts. In this manner, it is much more informative than the equity method. The equity method was favored by GAAP, which believed that it is a simpler and more straightforward approach of accounting for outside investments and avoids the cumbersome accounting work that is needed for the proportional consolidation method.

Abolishing Proportional Consolidation

The IFRS eventually came around to the simpler view of the equity method, and now the IFRS and GAAP are unified in using the equity method for accounting for interests in joint ventures.

Part of the overall mission of the IFRS is to standardize a clear approach for financial accounting so that interested parties around the world can better understand the operations of the firm no matter where it is located.

In addressing accounting for joint ventures, the IFRS wanted to eliminate inconsistencies in the reporting of "joint arrangements," which the IFRS classifies as either "joint operations" or "joint ventures," in accordance with IFRS 11. International Accounting Standards (IAS) 31 merged joint operations and joint ventures, and IFRS 11 requires the use of the equity method and the abolition of the proportional consolidation method.