An Ex Ante Analysis of Change in Reporting Methods: The Example of Joint Ventures

AN EX ANTE ANALYSIS OF CHANGE IN REPORTING METHODS: THE
EXAMPLE OF JOINT VENTURES
Frédéric Demerens, Anne Le Manh, Pascale Delvaille, Jean-Louis Paré
Association de Recherches et Publications en Management | « Gestion 2000 »
2014/4 Volume 31 | pages 65 à 89

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DOI 10.3917/g2000.314.0065
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Frédéric Demerens
Financial Reporting and
Audit Department
ESCP Europe, Paris
Anne Le Manh
Audit Department
ESCP Europe, Paris
Pascale Delvaille
Audit Department
ESCP Europe, Paris
Jean-Louis Paré
Novancia / CFVG Hanoï
An ex ante analysis of change

in reporting methods: the
example of Joint Ventures
I nternational joint ventures represent an increasingly attractive way to expand into
foreign markets while minimizing political and economic risks (Goldberg and Wolfe
1993; Freedman 1996). For example, half of the equity investments in the United States
represent investments in joint ventures (Stoltzfus and Epps 2005). The high percentage
of joint ventures underscores the need to understand accounting issues related to
joint ventures. Soonawalla (2006) noted there was little literature on accounting
for joint venture investments but during recent years a debate among international
accounting standards setters focuses on identifying the appropriate method of
reporting investments in joint ventures. There are basically two methods of reporting
investment in joint ventures: the equity method and the proportionate consolidation
method. The literature on joint ventures provides mixed results on the relevance of
one method over the other. Despite this unclear view and a strong opposition from
participants in the formal IASB’s due process, the international standard setter requires
in its new standard IFRS 11, issued in May 2011 and which supersedes the old IAS 31,
the exclusive use of the equity method for joint ventures. Soon after the release of IFRS
11, the IASB issued an effect analysis of the new standard which concluded that the
transition from IAS 31 to IFRS 11 would be of little effect on the financial statements
of groups operating joint venture activities. However, as explained later in the paper,
some weaknesses in the effect analysis undertaken by the IASB question the validity of
its conclusions.
Our research aims to provide new in- of IFRS 11 on the financial statements
sights into the effect analysis of the new of European companies. More preci-
accounting standard IFRS 11. It consists sely, our question is: will the transition
in an ex ante archival research simula- from the proportionate consolidation
ting the impacts of the implementation to the equity method have significant
65
Gestion 2000 4 juillet - août 2014
effects on the financial statements of dy (3). The final section concludes and
European companies? highlights the needs for supplementary
studies.
Our empirical study is based on a
sample of French, German, Spanish
and UK firms with joint venture activi-
Ex Ante effect analysis
ties, for which we have simulated the
transition from IAS 31 to IFRS 11. It re- literature
veals that the effects of the transition on
the consolidated financial statements Our research aims to contribute to the
of venturers are significant and more effect analysis of the adoption of the
substantial than reported by the IASB new IFRS 11. It consists in an ex ante
in its effect analysis document. Assets, archival research simulating the im-
liabilities, revenues and expenses si- pacts of the implementation of IFRS 11
gnificantly decrease under the equity on the financial statements of European
method, except for the German firms of companies.
the sample. The return on equity (ROE)
ratios are also significantly affected by
the change in consolidation method.
Effect analysis and standard
These results suggest that the costs of
analysis for users of the financial state-
setting
ments could be important.
Introducing a new accounting standard
The paper first explains the concept or even updating an existing standard
of “effect analysis” based on the defi- should have effects or consequences.
nitions and discussions proposed by Those effects or consequences are
both standard setters and academic likely to be of significance to many
researchers, particularly analysing the participants in the process. Integrating
ex ante effects or consequences a new an effect analysis in the standard set-
or updated accounting standard could ting due process has been a debate
have (1). The second section proposes for decades. But since October 2008,
a short presentation of the new stan- the requirement for an analysis of the
dard IFRS 11, reviews the academic anticipated effects of a new IFRS or a
literature on consolidation methods major amendment to an IFRS is now
for joint ventures and presents our re- included in the IFRS Foundation “Due
search hypotheses (2). The empirical Process Handbook for the IASB”(IFRS-
study is presented in the third section: Foundation 2012). The discussion
the methodology is described and we paper about “Considering the Effects
discuss the results of our empirical stu- of Accounting Standards” written by
66
An ex ante analysis of change in reporting methods: the example of Joint Ventures
the ASB and EFRAG sums up the main volatility of profit or loss, etc” (ANC
arguments in favour of integrating an 2011). Haller et al. (2012) also pro-
effect analysis into the standard setting vide an interesting comment on the dis-
due process. The main aims are “to cussion paper and detail the definition
strengthen that process and enhance its of the term “effects”.
transparency, to increase the accoun-
tability and credibility of the standard The effect analysis could be carried out
setter, and thus to contribute positively before (ex ante) or after adoption (ex
to delivering improved financial repor- post) of the standard. The term ‘effects’
ting” (ASB/EFRAG 2011). can be used to refer to both ‘anticipa-
ted effects’ and ‘actual effects’, depen-
ASB and EFRAG in the position pa- ding on what stage an effect analysis is
per define effects as “consequences at – before, during or after implemen-
that flow, or are likely to flow, from an tation of the new accounting standard
accounting standard” (ASB/EFRAG or amendment (ASB/EFRAG 2012b).
2012b). The IFRS Foundation, in stage Schipper (1994) reports that “Den-
5 of the due process handbook, pro- nis Beresford, Chairman of the FASB,
vides details about what is expected identified three kinds of evidence that
from an effect analysis. (IFRS-Foun- might be sought on an ex ante basis
dation 2012). In its comment letter to by standard setters: how would repor-
the discussion paper “Considering the ted results change under the proposed
Effects of accounting Standards”, the standard, how would corporate actions
French standard setter ANC has pro- change under the proposed standard;
posed to distinguish the assessments of what might be the effects on users’ (in-
the intrinsic quality of the accounting vestors’) decisions under the proposed
standard (internal consistency and suit- standard.”
ability for its immediate environment)
from the assessments of the external
effects of the standard (related to the
Effect analysis and academic
interaction of the standard and the
research
economy). Among those assessments
appears “the simulation of the effects
of the standard on the accounts show- Different papers extol the participation
ing the previous situation, the one of academics in the development of
resulting from the application of the accounting standards and insist on the
standard […] This aspect is crucial; fact that research can provide insights
it should identify the “immediate” ef- into accounting standard-setter issues
fects of the standard: increase of the (Barth 2000; Larson et al. 2011; Ab-
balance sheet, increased disclosures, ela and Mora 2012). Academics have
67
long recognised that they cannot vali- guish theoretical approaches from em-
date or set the standards but research pirical approaches. In order to serve
can inform standard setters about spe- ex ante researches, theoretical ap-
cific issues (Barth 2000). “Research proaches and experimental approach-
can aid standard setters in identifying es are well designed but in some cases
issues, structuring their thinking about archival methods could also be used
a particular issue, and providing evi- (McDaniel and Hand 1996; Fülbier et
dence that informs the debate about al. 2009; Trombetta et al. 2012). To
the issue” (Barth 2007). Larson et al. make ex ante research useful Schipper
(2011) invite academics to participate (1994) identifies four main qualities
in the standard setting process by writ- that lead to policy-relevance: immedi-
ing comment letters to the IASB during acy, comprehensive analysis of the en-
the due process. Two comment letters tire issue, conclusiveness and emphasis
(out of 31) written by academics were on the answer to the question.
received by the ASB/EFRAG concern-
ing the discussion paper “Considering
the Effects of Accounting Standards”.
Archival ex ante effect analy-
The comment letter from the EAA en-
sis papers
couraged the ASB/EFRAG (ASB/
EFRAG 2012a) to introduce in the
“next steps” section of the position Archival ex ante effect analysis consists
paper a project about the design and in simulating the effects of a new stan-
the test of “the methodology for effect dard or of changes in an accounting
analysis” and to consider the input of standard using empirical data. It could
academics: “The IASB and its partners, be done mainly in two ways. First,
that is the accounting standard bodies, the effects can be anticipated on a
should, where appropriate, rely on the sample by using the effects of similar
input of academics or other relevant standards that have been implemented
bodies when effect studies are being previously in other countries or juris-
performed” (ASB/EFRAG 2012b). dictions. For example, the implemen-
Among other arguments, academic tation of IFRS 8 could be compared
research is presented as rigorous and to the implementation of SFAS 131.
using rigorous methodologies leading But, because there remain differences
to more reliable results (Trombetta et between the two implementations
al. 2012). Trombetta et al. (2012) enu- (timing issues, standards are not fully
merate several methodologies which the same, samples are also different),
can be used for assessing the effects of extrapolating the effects of previous
accounting standards and give some accounting standards to other settings
examples for each of them. They distin- is very tricky (Trombetta et al. 2012).
68
Second, when data are available and about investors’ reactions, or an exclu-
a new standard allows it, we can simu- sive focus on one industry.
late the effects of a new standard or
an amendment by using the financial “What-if research” has largely been
data reported by the entities (Fülbier et conducted and discussed in the field
al. 2009; Trombetta et al. 2012). Fül- of leases where authors simulate the
bier et al. (2009) define this “what-if capitalization of off-balance sheet lease
research”: as a descriptive approach, obligations to determine effects on fi-
ex ante research involves simulation nancial statements and financial ratios
of the financial statements effects ex- (Imhoff Jr and Lipe 1991; Imhoff Jr et
pected from a specific recognition or al. 1997; Beattie et al. 1998; Bennett
measurement rule for certain events and Bradbury 2003; Goodacre 2003;
and transactions in order to compare Durocher 2008; Fülbier et al. 2008;
competing accounting solutions and Boatsman and Xiaobo 2011). It is also
to contrast them with pure notes dis- conducted in the field of preference
closures”. This approach doesn’t fit shares (De Jong et al. 2006) and in
all the new standards or amendments the field of stock option compensation
because it supposes a full access to (Dhar and De 2011). None of those
the entities’ data or / and availabi- studies, as well as the several ex ante
lity. Generally, authors have to extract studies focused on joint ventures issues
data from annual reports and from all and presented in the next section, deal
other sources of information provided with IFRS issues in a European perspec-
by the firms. The lack of access to data tive.
or/and the lack of availability of data
strongly reduce the number of ex ante
researches (Schipper 1994). In order
to compensate for the lack of data, Literature review on
Rees and Sutcliffe (1989) propose to reporting methods for
model the accounting data of the enti- joint ventures and hypo-
ties and simulate the earnings figures
theses development
produced by different accounting pro-
cedures. The same approach was used
by Healy et al. (2002) to examine the In this section we first propose a brief
trade-off between objectivity and rele- summary of the evolution of accoun-
vance of accounting information under ting treatment for joint ventures under
various methods of R&D reporting. IFRS. Then we present previous re-
Modelling accounting data involves search on reporting methods for joint
some limitations as, for example, sim- ventures and the development of our
plification of the data, assumptions hypotheses.
69
Reporting methods for joint it tended towards the equity method.

ventures under IFRS: from But, following a strong opposition
IAS 31 to IFRS 11 from constituents it moved towards the
proportionate consolidation (Camffer-
man and Zeff 2007). Eventually, in its
For many years, two main methods first standard on joint ventures, IAS 31
have been used around the world for (IASC 1990), the IASC recommended
reporting joint venture activities: the the use of the proportionate method
equity method and the proportionate as the preferred accounting treatment
consolidation method. Under the equi- for joint ventures but accepted also the
ty method a venturer’s net investment use of the equity method as the “other
in the joint venture is shown as a sin- accepted method”. The last version of
gle line item on the venturer’s balance IAS 31 (IASB 2009), while following
sheet as an asset and the venturer’s the recent policy of not referring to
net income or loss appears as a sin- a “preferred” method, explicitly de-
gle line item on the venturer’s income scribed the equity method as the “al-
statement as a financial gain or loss. ternative” to proportionate consolida-
Under the proportionate consolidation tion. The revision of IAS 31 became
method, the need for the equity meth- the same year a short-term conver-
od’s single line items disappears as gence project with the FASB. Discus-
the venturer’s share of each of the joint sions within the IASB took a long time
venture’s financial statement items is as Board members did not all agree
combined on a line-by-line basis with with the proposed elimination of pro-
its counterpart in the venturer’s finan- portionate consolidation. Eventually,
cial statements. These methods lead to ED 9 (IASB 2007) was published in
different amounts being presented in September 2007. While comment
the balance sheet, as assets and liabil- letters received by the IASB revealed
ities, in the income statement, as rev- that a majority of respondents didn’t
enues and expenses as well as in the support the IASB’s view, a slightly dif-
cash flow statement. The two methods ferent version of ED 9 was issued as
do not of course lead to different earn- the new IFRS 11 (IASB 2011b) which
ings numbers or different equity totals, confirms the elimination of the propor-
but the individual numbers within, and tionate consolidation method. A joint
therefore the whole internal structure venturer recognises its interest in a
of, the financial statements can be very joint venture as an investment using
much changed. the equity method in accordance with
IAS 28. Thus, the option to use pro-
When the IASC started to discuss the portionate consolidation, as permitted
joint ventures issue in the mid-1980s, by IAS 31, is removed.
70
Two months after the release of IFRS half of the ‘jointly controlled entities’
11, the IASB published a document were proportionately consolidated.
providing an effect analysis of the new Our reaction to this methodology is
standards IFRS 11 and IFRS 10 (IASB that, for example, it would have been
2011a). This step is now a mandatory more logical to adapt the proportion
one in the IASB’s due process for new of joint venture transactions by country
standards or major amendments. The to a larger sample of listed companies
IFRS 11 effect analysis includes four (perhaps all) by country. Finally, the
sections: an overview of joint venture IASB analysed the effect of IFRS 11 on
activities, a study on financial state- the financial statements of 19 compa-
ments effects, a cost-benefit analysis nies, European and non-European that
and a discussion on the US GAAP commented on ED 9 (IASB 2007) and
convergence issue. The second section used proportionate consolidation, men-
is of major interest for our research. tioning in a caveat that their analysis is
Indeed, the study analysis of financial “likely to significantly overstate the ave-
statements effects proposed by the rage effect of IFRS 11”’ (IASB 2011a).
IASB seems quite incomplete. On the basis of this sample, the effect
analysis details the change from pro-
Firstly, the table that details the ac- portionate method to equity method for
counting choices by country in the three financial indicators: assets, reve-
effect analysis document (page 16) nues and profitability ratio, but only
is based on a relatively small sample for the industry sub-samples. Effects on
of 144 companies (out of which more liabilities, expenses and other compo-
than 80% are registered in Europe, nents of ROE ratio are mentioned but
the main other ones being Hong not disclosed. Moreover, the applied
Kong and South Africa). It would be methodology is not sufficiently detailed
interesting to benefit from other avai- in the document to be assessed.
lable studies, for example coming from
national databases, in order to have Obviously, the weaknesses in the
a more accurate understanding of the IASB’s analysis make it difficult to draw
current situation. Secondly, in order to reliable conclusions on it and bring to
measure the effects of the IFRS 11 on light the necessity of more research on
accounting for joint arrangements and financial statements effects of a new
on entities’ main financial ratios, the standard.
IASB assumes first, that the population
of joint venture transactions (with 37%
of independent firms) is equivalent to
the population of arrangements within
the scope of IAS 31, and second, that
71
Previous research on Development of hypotheses

reporting methods for joint
ventures Most studies show that using propor-
tionate consolidation or equity method
Three main categories of papers dea- generates significant differences in the
ling with reporting methods for joint financial statements and in the finan-
ventures can be identified: cial ratios. Several of them suggest that
• Theoretical or normative papers: proportionate consolidation is a better
they discuss the different accounting accounting solution for reporting joint
solutions and may support one of venture activities. Moreover all the
identified ex ante studies have been
them and they do not include any
empirical studies. undertaken in a national context, with
• Ex post or value relevance studies: samples of firms applying national stan-
they intend to prove the value rele- dards or national case studies. In this
vance of some disclosures on joint paper, we focus on European compa-
ventures activities or to identify nies that apply IFRS. Finally, as explai-
the more value relevant reporting ned before, the IFRS 11 effect analysis
methods for joint ventures. They only undertaken by the IASB does not pro-
use the accounting data as published vide reliable conclusions. We therefore
by firms in their annual reports. These intend to analyse the effects on finan-
studies obtain different results. cial statements of the implementation
• Ex ante studies: most of them seek of the new IFRS 11, which implies that
to compare the value-relevance for entities applying proportionate conso-
users of equity method and propor- lidation for their joint venture activities
tionate consolidation. They do not will have to use equity method starting
intend to analyse the effects of a from January 20131. Moving from
new standard but they use pro-forma the proportionate consolidation to the
data which simulates either the use of equity method will impact revenues,
equity method or the use of propor- expenses, assets and liabilities. Bau-
tionate consolidation. They do not man (2003) and Graham et al. (2003)
obtain convergent results. show that, respectively in the American
and Canadian context, a change in the
Most important papers are presented consolidation method of joint ventures
in table 1 following the previous classi- would significantly impact the consoli-
fication and depending on their conclu- dated financial statements of investors
sions. in joint ventures. Moreover Graham et
1 However, the mandatory application of IFRS
11 has been postponed to January 2014 for
European Union companies.
72
Table 1: Literature review
1. Normative papers
• Bierman (1992) - PC(b): the study suggests that the use of equity accounting rather than proportionate
consolidation, by failing to reflect liabilities of investees, may allow those investees to be used as an
off-balance-sheet-financing device.
• Milburn and Chant (1999) - EM(a): the paper written by the G4+1, proposes to harmonize the
accounting for joint ventures in countries members of the G4+1 and supports the equity method.
• Nobes (2002) - NC(c): this paper traces the development of the equity method across time and space,
and criticizes several of the past and present applications of this method.
2. Ex post studies
• Lourenco and Curto (2010) - PC(b): the study investigates what determines the venturer’s accounting
choice to report interests in jointly controlled entities (JCE) using the equity method or proportionate
consolidation. Their findings provide evidence that link venturers are more likely to apply proportionate
consolidation. The contribution suggests that requiring all ventures to report interests in JCE using one
method (the equity method wanted by IASB) would tend to reduce the reliability of financial statements
not representing the substance of JCE.
• Richardson, Roubi and Soonawalla (2012) - NC(c): the authors use a sample of Canadian companies
over the period 1985–2003 reflecting a reduction of choice in financial reporting methods for joint
ventures.
The firms that were forced to switch from equity method to proportionate method experienced a decline
in value relevance of reported assets and liabilities. The firms that used proportionate consolidation
for the entire sample period experience no such decline. Results suggest that the removal of choice
of financial reporting method does have value-relevance implications and that the requirement of
additional disclosure of joint venture assets and liabilities is value relevant, which may offset, to some
extent, the costs of the reduction in choice.
3. Ex ante studies
• Davis and Largay (1999) - PC(b): this study contrasts the information provided by proportionate
consolidation, the expanded equity method and the conventional equity method for reporting and
analysing significant-influence equity investments. It evaluates whether these methods facilitate sound
ratio approaches to assessing an entity’s profitability, short-term liquidity risk and long-term solvency
risk. The study recommends replacing the equity method with proportionate consolidation when an
investor and investee are operationally related.
• Bauman (2003) - NC(c): Bauman’s study uses a sample of 150 US firms for the years 2000 and
2001 to examine:
– First the impact on assets, liabilities and revenues of a move from equity method to PC and
concludes that the impact is significant.
– Second the value relevance to investors of disclosures of off-balance sheet activities concealed by the
equity method of accounting.
• Kothavala (2003) - NC(c): the study, using a sample of Canadian firms, investigates the relative
information content of equity method and proportionally consolidated financial statement amounts
for explaining market risk. It reveals that proportionally consolidated financial statements are more
risk relevant than equity method statements for explaining price volatility, but that equity method
statements are more risk relevant than proportionally consolidated ones for explaining bond ratings.
These findings suggest that different market participants use financial statement information differently
73
Graham et al. (2003) - PC(b): the study compares the information content of alternative accounting
treatments for a sample of Canadian firms reporting joint ventures under proportionate consolidation.
After restating their financial statements using the equity method, the study compares the information
content of the two accounting methods in predicting accounting return on common shareholders’
equity. The study finds 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. As a consequence, proportionate consolidation
provides information with greater predictive ability and greater relevance than does the equity method.
• Stoltzfus and Epps (2005) - PC(b): the study examines bond risk premiums to determine whether
creditors of companies with investments in joint ventures reflect legal or implicit measures of the debts
of joint ventures. The legal view suggests that the amount of potential loss from an investment in a
joint venture is limited to the investment. The implicit view suggests that the operations of the joint
venture and the venturer are interdependent. The equity method accounting reflects the legal view and
proportionate consolidation reflects the implicit view. A change to proportionate consolidation would
provide more value relevant information to creditors when companies guarantee the debt of the joint
venture.
• Bauman (2007) - PC(b): the move from equity method to proportionate consolidation is simulated
on a sample of 40 American companies and 156 observations. The study suggests that the use
of proportionate consolidation has greater value relevance than equity method for explaining bond
ratings.
(a) EM: Equity Method is a better reporting method for joint ventures than proportionate consolidation.
(b) PC: Proportionate Consolidation is a better reporting method for joint ventures than equity method
(c) NC: Do not conclude to the superiority of one reporting method for joint ventures over another one.
al. (2003), in their study undertaken in FRS 11, will have significant effects
the Canadian context, reveal that the on the assets disclosed in the ba-
move from proportionate consolida- lance sheet of large European firms
tion to equity method has significant with joint venture activities.
effects on the components of the return
on equity ratio (ROE) as defined by We expect a significant decrease in
the Dupont Model (ROE = Profit Mar- total assets (total assets after restate-
gin x Total Assets Turnover x Leverage ment should be lower than total assets
Ratio)2. Based on these previous results disclosed by the firms using the pro-
our hypotheses are: portionate consolidation method). This
expectation stems from the different ac-
Hypothesis1a (H1a): Moving from counting records of the two methods. In
proportionate consolidation to order to complement prior researches,
equity method, as required by I we assess the impact on non-current
and current assets.
2 Where:
ROE = Net Income / Equity (at the end of FY)
Profit Margin = Net Income / Revenues Hypothesis1b (H1b): Moving from
Total Assets Turnover = Revenues / Total Assets
Leverage Ratio = Total Assets / Equity (at the
proportionate consolidation to equi-
end of FY) ty method, as required by IFRS 11,
74
will have significant effects on the We expect a significant decrease in

liabilities disclosed in the balance the expenses (expenses after restate-
sheet of large European firms with ment should be lower than expenses
joint venture activities. disclosed by the firms using the pro-
portionate consolidation method).
We expect a significant decrease in This expectation stems from the dif-
total liabilities (total liabilities after res- ferent accounting records of the two
tatement should be lower than total lia- methods.
bilities disclosed by the firms using the
proportionate consolidation method). Hypothesis 2a (H2a): Moving from
This expectation stems from the dif- proportionate consolidation to
ferent accounting records of the two equity method, as required by IFRS
methods. In order to complement prior 11, will have significant effects on
researches, we assess the impact on the profit margin of European firms
non-current and current liabilities. with joint venture activities.
Hypothesis1c (H1c): Moving from Because the change of method gene-

proportionate consolidation to equi- rates lower revenues without affecting
ty method, as required by IFRS 11, the net income, we expect an increase
will have significant effects on the in the profit margin.
revenues disclosed in the income
statement of large European firms Hypothesis 2b (H2b): Moving from
with joint venture activities. proportionate consolidation to equi-
ty method, as required by IFRS 11,
We expect a significant decrease in will have significant effects on the
the revenues (revenues after restate- Total Assets Turnover of European
ment should be lower than revenues firms with joint venture activities.
disclosed by the firms using the pro-
portionate consolidation method). This The change of method generates lower
expectation stems from the different ac- revenues and lower assets. We can’t
counting records of the two methods. anticipate the trend from the accoun-
ting changes generated by the change
Hypothesis1d (H1d): Moving from of method. Graham et al. (2003) found
proportionate consolidation to equi- a decrease in this ratio.
ty method, as required by IFRS 11,
will have significant effects on the Hypothesis2c (H2c): Moving from
expenses disclosed in the income proportionate consolidation to equi-
statement of large European firms ty method, as required by IFRS 11,
with joint venture activities. will have significant effects on the
75
Leverage Ratio of European firms dation to the equity method on the ven-
with joint venture activities. turers’ financial statements and on the
DuPont Model which disaggregates the
The change of method generates lower rate of return on equity.
assets without changing the equity,
thus we expect a decrease in the leve- We focus on European Union firms re-
rage ratio. porting under IFRS and using proportio-
nate consolidation in 2008 and 2009.
We extract those companies from four
Empirical study European indexes: CAC 40 (French
index), DAX 30 (German index), FTSE
100 (British index) and IBEX 35 (Spa-
Considering the limitations of the effect
nish index). Those indexes were chosen
analysis, we have undertaken an empi-
from the ranking of the four major market
rical study on a larger sample in order
capitalizations of the European Union’s
to obtain more convincing results on the
exchanges. In order to balance the
effects of a transition from proportionate
sample we limit our study to the first 50
consolidation to the equity method.
FTSE capitalizations. The initial sample is
then composed of 155 European firms.
Methodology and sample Analysing the annual reports for FY

description 2009 we looked for the firms that use
proportionate consolidation and that
We use the methodology from Graham disclose financial information (assets,
et al. (2003). We create pro forma liabilities, revenues and expenses)
equity method balance sheets from pro- about joint ventures. Table 2 shows the
portionate consolidation balance sheets sample distribution. A large majority
by subtracting joint venture liabilities of the firms disclose information about
from the venturer’s total assets and from joint ventures, but 24 firms do not. In
the venturer’s total liabilities. Similarly, the sample, joint venture accounting
we create equity method income state- remains a real issue at stake. Among
ments from proportionate consolidation the firms that disclose information
income statements by eliminating joint about joint ventures the two accoun-
venture revenues and expenses, and ting methods are quite balanced: 67
adding the difference between joint firms are using the equity method and
venture revenues and expenses to the 64 firms are using the proportionate
venturer’s other revenues and expenses. consolidation. In the sample, propor-
Then we calculate the effect of the tionate consolidation is not that mar-
conversion from proportionate consoli- ginal. Only 35 firms using proportio-
76
Table 2: Sample distribution
Joint Venture Accounting
No joint ven- Proportionate

ture or Consolidation
Equity
No joint No joint Total
Method Final
venture Total venture %
Information Sample
Information
INDEX CAC40 2 9 29 17 12 34% 40

DAX30 7 20 3 0 3 9% 30
FTSE100 9 29 12 2 10 29% 50
IBEX35 6 9 20 10 10 29% 35
Total 24 67 64 29 35 100% 155
nate consolidation disclose enough Disclosures about joint venture reve-

financial details about joint ventures to nues, expenses and profit are heteroge-
restate financial statements and create neous. The disclosure of joint venture
pro forma equity method financial sta- operating profit information (operating
tements. This proportion is comparable revenues and expenses, and / or ope-
to the proportion found by Graham et rating profit) is not systematic. Only 18
al. (2003): 78 firms out of 158 using firms using proportionate consolidation
proportionate consolidation disclosed disclose such information. In order to
financial details about joint ventures. keep a more significant sample we
focus on global data of the income sta-
The final sample is composed of 35 tement: total revenues, total expenses
European firms (see companies’ names and net income.
in Appendix 1) using proportionate
consolidation and observed for FY Appendix 2 and Appendix 3 show
2008 and 2009: this represents 70 the involvement of joint ventures in the
observations3. venturer’s financial statements. Even if
the purpose of some joint ventures is
3 For the Spanish subsample we found that mainly to share costs (e.g. prospec-
69% of the listed companies that disclosed ting costs) and not to generate reve-
information about their accounting methods for
joint ventures chose the proportionate consoli- nues, most of the joint ventures of our
dation. The comparative study of Catuogno and sample provide revenues and profits to
Allini (2011) on the multiple evaluation options
of equity investments in Italy and Spain gives
the venturer. Joint venture revenues, on
the following results : in a sample of 98 listed average, represent almost 11% of the
companies 80% of Spanish companies used venturer’s total revenues. Compared
the proportionate method (29 out of 35 that
disclosed this information). to the total net income of the venturer,
77
joint venture profit is quite significant and liabilities are reduced by 8.46%4.
(mean of 22.4%). Appendix 4 reports We notice that there are some very
that most of the joint ventures (95.7%) large effects among each index and
and most of the venturers (94.3%) the range of the differences (min. to
report positive earnings (net income). max.) is usually great. Firms from DAX
These findings are consistent with, 30 and FTSE 100 are less impacted
but higher than, those of Graham et than firms within CAC 40 and IBEX 35.
al. (2003). Respectively, they found All the mean differences are significant
a proportion of 79.4% and 84.9%. except for DAX 30 where the sample is
Generally, joint ventures boost the ear- very small. We conclude that H1a and
nings of their venture. On average, H1b are validated.
joint venture assets represent more
than 9% of total assets of the venturer We can add that the conversion from
and more than 8% of venturer’s total proportionate consolidation to the
liabilities. Extreme figures for IBEX 35 equity method can also affect the cal-
mainly come from the venturing activity culation of the working capital of the
of Acciona Group and Enel SPA about venturer or of other detailed ratios. Dif-
Endesa S.A. ferences in current assets and in cur-
rent liabilities are great (respectively
-9.69% and -10.43% on average) and
Results frequently higher than the differences
in non-current assets and in non-current
liabilities (Table 4).
In this section we present the effects
of joint venture accounting method Conversion of joint venture accounting
conversion on the financial state- method has no impact on net income but
ments and on the ROE ratios of the it does affect revenues and expenses of
venturers. the venturer’s income statements. Table
5 reports that on average revenues are
reduced by 10.85%, while expenses
The effects of joint venture accoun- are reduced by 10.25%. Results are
ting method conversion on the finan- consistent with the findings of Graham
cial statements of the venturers et al. (2003)5.
As we can expect, conversion from pro- Globally, firms from the German index
portionate consolidation to the equity and the English index are again less
method reduces assets and liabilities of
4 Graham et al. (2003) found respectively
the venturers. Table 3 reports that on -7.35% and -14.18%.
average, assets are reduced by 6.19% 5 Graham et al. (2003) found -13.5%.
78
Table 3: Differences in balance sheets (n=70)

Difference in Total Assets Difference in Total Liabilities

(as a % of reported Assets) (as a % of reported Liabilities)
Wilcoxon Wilcoxon
Min. Mean Median Max. Min. Mean Median Max.
test test
CAC40 -16.32% -5.00% (*) -3.25% -0.36% *** -20.48% -6.73% (*) -4.65% -0.57% ***
DAX30 -2.87% -0.96% -0.20% -0.03% ** -4.54% -1.49% -0.27% -0.03% **
FTSE100 -5.60% -1.79% (*) -1.14% -0.06% *** -11.51% -3.40% (*) -1.54% -0.19% ***
IBEX35 -13.58% -17.70%
-68.36% -7.76% -0.01% *** -79.65% -9.97% -0.01% ***
(*) (*)
Total -68.36% -6.19% (*) -2.50% -0.01% *** -79.65% -8.46% (*) -4.10% -0.01% ***
(*): Significant T-Test at 95% Confidence Interval
*significant at a 10% level; ** significant at a 5% level, *** significant at a 1% level.
Table 4: Differences in non-current and current components

(as a % of reported item) (n=70)
Difference in Difference in Difference in
Difference in Current Liabilities
Non- Current Assets Current Assets Non- Current Liabilities
Wilcoxon Wilcoxon Wilcoxon Wilcoxon
Mean Mean Mean Mean
test test test test
CAC40 -6.29% (*) *** -7.86% (*) *** -3.99% (*) *** -9.20% (*) ***
DAX30 -1.59% ** -1.64% ** -1.21% ** -2.01% **
FTSE100 -7.22% (*) *** -4.64% (*) *** -2.65% (*) *** -4.56% (*) ***
79
IBEX35 -13.44% (*) *** -19.34% (*) *** -11.31% (*) *** -20.29% (*) ***
Total -8.20% (*) *** -9.69% (*) *** -5.46% (*) *** -10.43% (*) ***
(*) : Significant T-Test at 95% Confidence Interval
Table 5: Differences in income statements (%) (n=70)
Difference in Revenues Difference in Expenses

(as a % of reported Revenues) (as a % of reported Expenses)
Gestion 2000
Wilcoxon Wilcoxon
4
80
test test
CAC40 -23.71% -8.15% (*) -5.77% *** -0.73% -21.94% -7.83% (*) -5.82% -0.61% ***
DAX30 -8.65% -2.83% -0.40% ** -0.15% -8.86% -2.82% -0.38% -0.15% **
FTSE100 -18.86% -6.40% (*) -5.09% *** 0.00% -17.86% -5.62% (*) -4.59% -0.22% ***
juillet - août 2014
IBEX35 -84.21% -20.95% (*) -10.35% *** -1.96% -71.96% -20.01% (*) -10.32% -1.90% ***
Total -84.21% -10.85% (*) -5.62% *** 0.00% -71.96% -10.25% (*) -5.28% -0.15% ***
(*) : Significant T-Test at 95% Confidence Interval
Table 6: Descriptive Statistics of ROE ratios, Wicoxon test and T-Test (n=70)
Proportionate Consolidation
Profit Margin Total Assets Turnover Leverage
Mean Median Std. Dev. Mean Median Std. Dev. Mean Median Std. Dev.
CAC40 5.34% 5.46% 3.82% 0.65 0.65 0.20 4.03 3.23 1.86
DAX30 2.69% 3.81% 3.34% 0.84 0.81 0.44 7.04 2.98 9.64
FTSE100 16.02% 13.89% 15.01% 0.53 0.46 0.46 7.78 2.64 11.74
IBEX35 15.23% 12.05% 13.08% 0.57 0.43 0.46 5.69 3.56 5.44
Total 10.99% 7.05% 12.02% 0.61 0.58 0.39 5.83 3.24 7.51
Equity Method (Pro-Forma)
Profit Margin (%) Total Assets Turnover Leverage
Wilcoxon Wilcoxon Std. Wilcoxon Std.

Mean Median Std. Dev. Mean Median Mean Median
Test (2) Test (2) Dev. Test (2) Dev.
0.63 3.79
CAC40 5.81 (1) 6.31 *** 4.01 0.63 *** 3.06 *** 1.68
(1) 0.20 (1)
DAX30 2.82 3.94 3.44 0.78 ** 2.95 ** 9.65

0.82 0.42 7.02
0.51 7.70
FTSE100 17.09(1) 15.18 *** 15.32 0.45 *** 2.61 *** 11.66
(1) 0.46 (1)
4.84
IBEX35 19.39(1) 15.77 *** 13.15 0.37 *** 3.25 *** 5.43
0.56 0.50 (1)
Total 12.66% 9.04% *** 12.73% 0.59 0.58 *** 0.40 5.49 3.05 *** 7.48
Mean -0.01666 0.0181 0.3471
Std. Deviation 0.0381 0.0554 0.9215

T -3.659
2.729 3.151
Sig. (2-tailed) 0.000* 0.008* 0.002*

*95% Confidence Interval
(1) : Significant difference in mean between proportionate consolidation indicator and restated equity method indicator (T-Test at 95% Confidence Interval)
(2) : Wilcoxon test between proportionate consolidation indicator and restated equity method indicator.
81
impacted than firms from the Spanish conversion of the joint venture accoun-
index and the French index. However, ting method. Their decrease is signifi-
all the mean differences are significant cant enough to validate H2b and H2c
except for DAX 30. H1c and H1d are but it is not very strong on average.
validated. Within indexes differences can be dee-
per. The standard deviations of these
The effects of joint venture accoun- two ratios are not very impacted by the
ting method conversion on ROE ratios conversion.
of the venturers
These results supplement the results of
Table 6 reports the results and the distri- the effect analysis done by the IASB (see
bution of the calculations of the different supra). Our sample is larger and the in-
ratios for the proportionate consolida- dicators are more numerous. From this
tion data and for the equity method first contribution we can argue that the
data (pro forma). Conversion of the joint conversion from proportionate consoli-
venture reporting method generates an dation to equity method is not insignif-
increase of 1.67 percentage points of icant. The conversion should affect the
the profit margin ratio of the venturers: structure of the balance sheet and the
the ratio increases from 10.99% to profit margin ratio of many venturers.
12.66% on average. All the mean diffe-
rences are significant, except again for IASB argues in the effect analysis doc-
the DAX companies. H2a is validated. ument that “As a result, this analysis is
Contrary to the Graham et al. findings, likely to significantly overstate the aver-
the standard deviation of the profit mar- age effect of IFRS 11”. Table 7 shows
gin ratio of the sample does not increase that the results of the IASB effect analy-
very much. In our case, this signifies that sis are not so much overstated.
conversion from proportionate consoli-
dation to equity method does not affect As with the IASB effect analysis the
extreme observations. The difference first limitation of our research is that
between Graham et al. findings and we assume that the population of joint
ours must probably stem from the com- venture transactions is equivalent to the
position of the sample (nature of indus- population of arrangements within the
tries observed for example). Firms from scope of IAS 31.
the French and the German indexes are
less impacted than firms from English The second limitation stems from the
and Spanish indexes. fact that our research doesn’t assess
the impact of change of method on the
Total assets turnover and leverage ra- statement of cash flow. But the change
tios are not that much impacted by the of method does have an impact on
82
Table 7 – Medians’ differences between IASB’s effect analysis and our research
Assets Liabilities Revenue Profit Margin

Medians
(impact -) (impact -) (impact -) (impact +)
From -2% to - From -2.9% to From +0.4 to

IASB
13.7% -28.1% +9.8 (points)
Our Results - 2,5% - 4.1% - 5.6% + 2 (points)
the statement of cash flow. An ex ante dation for joint ventures till 2013 will
measure of this impact needs inner have to change the method of consol-
data from the firms, data which are not idation and will have to switch to the
disclosed. equity method. In order to improve its
due process and in order to assess the
Nevertheless, this research faces some impact of the new standard the IASB
other limitations. First, the sample size proceeded to carry out one of its first
is small and could be improved. Fur- effect analysis which concluded to
thermore, a larger sample could lead minimize the impact induced from the
to more detailed restatements (opera- change of method. This research con-
ting margins, taxes…). Second, the tributes to complement the effect anal-
research can be detailed by industries. ysis carried out by the IASB proposing
We suppose that results could be more an ex ante measure of the impact of
significant in some industries where change of method on European firms’
joint ventures are strategically and financial information.
economically predominant. Third, this
research could also be supplemented From prior literature we assume that
by the analysis of some users’ beha- the change of method of consolidation
viour concerning joint ventures’ finan- should have significant effects on the
cial analysis. Financial analysts should financial statements figures (H1) and
be considered as privileged users. on the ratios disaggregated from the
ROE (H2). First, our results suggest that
the assets and the liabilities of the en-
Conclusion tities should significantly decrease. In
some isolated cases, where joint ven-
tures are very important in the business
IFRS 11, compulsory from 1st of Janu-
model, the decrease is very impres-
ary 2013, requires the equity method
sive. Revenues and expenses are also
as the only consolidation method for
significantly affected by the change of
joint ventures. Many firms which have
method and should decrease by more
been using the proportionate consoli-
than 10% in average. Necessarily, all
83
the ratios which are using those figures one hand, and one single conceptual
may be altered. Second, our results sug- framework on the other. Since a joint
gest that the three ratios disaggregated venture involves joint control over the
from the ROE ratio (profit margin, total net assets of the entity (in contrast to
assets turnover and leverage) are sig- a joint operation, which involves joint
nificantly impacted by the change of control over the separate assets and
method of consolidation. The increase liabilities of the operation), there can
of the profit margin appears to be not be no doubt that, if the definition of
inconsiderable. control in IFRS 10 is accepted, con-
ceptual logic, and consistency with the
Our research also points out the limi- Conceptual Framework, supports the
tations of such ex ante effect analysis rejection of proportionate consolida-
for academics as for standard setters. tion. This argument is strong, but not
In order to refine our results we should of itself conclusive. Coherence with
need internal data from the firms such the economic substance of the busi-
as joint ventures’ cash flows details or ness operations of and between the
arrangements’ details. venture and its venturers, and a fair
presentation (true and fair view) of that
Beyond the potential and significant substance, is the determining factor. In-
impact of the change of method on the ternational firms, adopting innovative
financial statements and their analysis, business models, have abolished geo-
the adoption of IFRS 11 reflects several graphic, economic or financial fron-
challenges that standard setters must tiers requiring the standard setters such
deal with. In an effort to improve the as the IASB to continuously shape new
due process of the standard setting, the accounting standards and to arbitrate
IASB has entered into the introduction between different points of view, dif-
of effect analysis during the whole pro- ferent considerations of the value. As
cess of the updating or the introduction Charpentier identified in 19296, “The
of an accounting standard. The limita- man who counts tons of coal at the pit-
tions of the effect analysis of IFRS 11 head of a mine, or pairs of shoes in a
should question IASB about the numer- store...is only doing additions and sub-
ous traps related to ex ante analysis, tractions. He becomes an accountant
mainly linked to the lack of data. This only when he attributes to objects a fig-
should strengthen its relationship with ure representative of their value”. The
firms, stakeholders and academics. accounting objects are almost infinite
Accounting standardization and har- today, the representation of their value
monization must also compromise on
6 Charpentier, J. (1929). Preface. In Introduction
the difficult contrast between a variety
à la technique comptable (Penglaou, C.). Paris :
of different business models on the Les Presses Universitaires de France, V-VIII..
84
varies from one stakeholder to another. Beattie, V., Edwards, K., Goodacre, A. (1998).
The impact of constructive operating lease capi-
Thus, the elimination of the proportion- talisation on key accounting ratios. Accounting
ate consolidation method from IFRS 11 & Business Research 28: 233-254.
stems from a current representation of
Bennett, B. K., Bradbury, M. E. (2003). Capi-
the value of joint ventures for investors talizing Non-cancelable Operating Leases. Jour-
but is still debatable. nal of International Financial Management &
Accounting 14: 101-114.
Bierman Jr, H. (1992). Proportionate Consoli-

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Appendix 1 – Companies’ names
CAC 40 DAX 30 FTSE 100 IBEX 35
ACCOR Basf Vodafone Group ACCIONA
AIR LIQUIDE Bayer AG BHP Billiton ACS CONST.
BOUYGUES DHL Deutsche Post Anglo American BOLSAS Y MER
EADS Xstrata GAS NATURAL
EDF Standard Chartered IBE.RENOVABL
GDF SUEZ Diageo IBERDROLA
L’OREAL Imperial Tobacco Group INDITEX
LAFARGE Prudential REPSOL YPF
SAINT GOBAIN Antofagasta TECNICAS REUNIDAS
TECHNIP Compass Group TELEFONICA
VEOLIA ENV.
VINCI
87
Appendix 2 – Significance of joint venture in the income statement (n=70)
Part of joint venture in Total Revenues Part of joint venture in Total Expenses Part of joint venture in Net Income (Abs.)
Gestion 2000
Min. Mean Median Max. Min. Mean Median Max. Min. Mean Median Max.
4
88
CAC40 0.73% 8.15% 5.77% 23.71% 0.61% 7.83% 5.82% 21.94% 2.02% 15.21% 6.89% 62.35%
DAX30 0.15% 2.83% 0.40% 8.65% 0.15% 2.82% 0.38% 8.86% 0.22% 3.43% 1.04% 12.81%
FTSE100 0.00% 6.40% 5.09% 18.86% 0.22% 5.62% 4.59% 17.86% 0.63% 17.89% 3.64% 149.25%
juillet - août 2014
IBEX35 1.96% 20.95% 10.35% 84.21% 1.90% 20.01% 10.32% 71.96% 0.10% 41.31% 10.74% 303.55%
Total 0.00% 10.85% 5.62% 84.21% 0.15% 10.25% 5.28% 71.96% 0.10% 22.42% 7.02% 303.55%
Appendix 3 – Significance of joint venture in the balance sheet (n=70)
Part of joint venture in Total Assets Part of joint venture in Total Liabilities
CAC40 0.98% 7.23% 5.31% 24.43% 0.57% 6.73% 4.65% 20.48%
DAX30 0.05% 1.58% 0.35% 4.41% 0.03% 1.49% 0.27% 4.54%
FTSE100 0.54% 5.82% 1.97% 18.85% 0.19% 3.40% 1.54% 11.51%
IBEX35 0.11% 18.74% 10.46% 76.43% 0.01% 17.70% 9.97% 79.65%
Total 0.05% 9.63% 4.40% 76.43% 0.01% 8.46% 4.10% 79.65%
Appendix 4 – Percentages of joint ventures and venturers with positive Earnings (n=70)
Joint Ventures Venturers
CAC 40 95.8% 91.7%
DAX 30 100% 83.3%
FTSE 100 90% 95%
IBEX 35 100% 100%
Total 95.7% 94.3%

89

An Ex Ante Analysis of Change in Reporting Methods: The Example of Joint Ventures

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AN EX ANTE ANALYSIS OF CHANGE IN REPORTING METHODS: THE

EXAMPLE OF JOINT VENTURES

Frédéric Demerens, Anne Le Manh, Pascale Delvaille, Jean-Louis Paré

Association de Recherches et Publications en Management | « Gestion 2000 »

2014/4 Volume 31 | pages 65 à 89

Distribution électronique Cairn.info pour Association de Recherches et Publications en Management.

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An ex ante analysis of change

Reporting methods for joint it tended towards the equity method.

Previous research on Development of hypotheses

Table 1: Literature review

will have significant effects on the We expect a significant decrease in

Hypothesis1c (H1c): Moving from Because the change of method gene-

Methodology and sample Analysing the annual reports for FY

Table 2: Sample distribution

Joint Venture Accounting

No joint ven- Proportionate

INDEX CAC40 2 9 29 17 12 34% 40

nate consolidation disclose enough Disclosures about joint venture reve-

Table 3: Differences in balance sheets (n=70)

Table 4: Differences in non-current and current components

Table 5: Differences in income statements (%) (n=70)

Difference in Revenues Difference in Expenses

Profit Margin Total Assets Turnover Leverage

Equity Method (Pro-Forma)

Profit Margin (%) Total Assets Turnover Leverage

Wilcoxon Wilcoxon Std. Wilcoxon Std.

DAX30 2.82 3.94 3.44 0.78 ** 2.95 ** 9.65

Mean -0.01666 0.0181 0.3471

Std. Deviation 0.0381 0.0554 0.9215

Sig. (2-tailed) 0.000* 0.008* 0.002*

Assets Liabilities Revenue Profit Margin

From -2% to - From -2.9% to From +0.4 to

Bierman Jr, H. (1992). Proportionate Consoli-

Boatsman, J., Xiaobo, D. (2011). EquityValue

Schipper, K. (1994). Academic Accounting Stoltzfus, R. L., Epps, R. W. (2005). An empirical

CAC 40 DAX 30 FTSE 100 IBEX 35

ACCOR Basf Vodafone Group ACCIONA

AIR LIQUIDE Bayer AG BHP Billiton ACS CONST.

BOUYGUES DHL Deutsche Post Anglo American BOLSAS Y MER

EADS Xstrata GAS NATURAL

EDF Standard Chartered IBE.RENOVABL

GDF SUEZ Diageo IBERDROLA

L’OREAL Imperial Tobacco Group INDITEX

LAFARGE Prudential REPSOL YPF

SAINT GOBAIN Antofagasta TECNICAS REUNIDAS

TECHNIP Compass Group TELEFONICA

Appendix 2 – Significance of joint venture in the income statement (n=70)

Appendix 3 – Significance of joint venture in the balance sheet (n=70)

Min. Mean Median Max. Min. Mean Median Max.

CAC40 0.98% 7.23% 5.31% 24.43% 0.57% 6.73% 4.65% 20.48%

DAX30 0.05% 1.58% 0.35% 4.41% 0.03% 1.49% 0.27% 4.54%

FTSE100 0.54% 5.82% 1.97% 18.85% 0.19% 3.40% 1.54% 11.51%

IBEX35 0.11% 18.74% 10.46% 76.43% 0.01% 17.70% 9.97% 79.65%

Total 0.05% 9.63% 4.40% 76.43% 0.01% 8.46% 4.10% 79.65%

Joint Ventures Venturers

CAC 40 95.8% 91.7%

DAX 30 100% 83.3%

FTSE 100 90% 95%

IBEX 35 100% 100%

Total 95.7% 94.3%

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DAX30 2.82 3.94 3.44 0.78 2.95 9.65