Example of Carried Interest with Penalty Calculations and Payout
This example shows how Joint Venture Management processes a carried interest agreement with a penalty definition. It explains how the application calculates penalties on carried costs, applies carried revenue, and determines payout.
The Setup
In this scenario, a joint venture accountant sets up a penalty definition to calculate the following penalties for a carried interest agreement:
- 150% penalty on billable assets
- 200% penalty on expenses for building materials
The accountant then opens the carried interest agreement and selects the following options to enable the calculation of penalties and balance tracking to determine payout:
- Calculate penalty and balances
- Determine payout
The Processing and Tracking of Carried Interest with Penalties
Over three periods, the accountant runs the processes to distribute transactions and create carried interest distributions. For each period, Joint Venture Management calculates penalties on carried costs, allocates carried revenue against those costs, and updates the following running balances:
- Total carried amount
- Total penalty amount
- Total carried amount plus penalty amount
| Carried Amount ($) | Penalty % | Penalty Amount | Total Carried | Total Penalty | Total Carried + Penalty | Percentage (for revenue calculation) |
|---|---|---|---|---|---|---|
| 100 (asset) | 150% | 50 | 100 | 50 | 150 | |
| 500 (expense) | 200% | 500 | 600 | 550 | 1150 | 0.478260869565217 |
| -140 (revenue) |
(-73.04) 526.96 |
(-66.96) 483.04 |
1010 |
0.478257425742574 |
||
| -60 (revenue) |
(-31.30) 495.66 |
(-28.70) 454.34 |
950 |
0.478252631578947 |
As shown in the table, Joint Venture Management calculates penalties for carried costs using this formula:
Penalty Amount = (Carried Cost Amount × Penalty Percentage) – Carried Cost Amount
For example:
$50 = (100 x 150%) – 100
$500 = (500 x 200%) – 500
The next rows show carried revenue applied to the balances. Revenue is allocated using the percentage from the preceding row, shown in the last column. This percentage is calculated as:
Percentage = Total Penalty ÷ Total Carried + Penalty
For example:
0.478260869565217 = 550 ÷ 1150
This percentage determines how revenue is split between the carried balance and the penalty balance. For the $140 revenue amount:
$140 X 0.478260869565217 = 66.96
140 – 66.96 = 73.04
As shown in the preceding table, 66.96 and 73.04 are subtracted from the total penalty balance and total carried balance respectively.
After updating the balances, the application recalculates the percentage and applies it to the next revenue amount. This process continues for each revenue transaction in the period.
The application performs calculations on carried amounts by transaction date, starting with the first day of the period. For each date, it first calculates penalties on carried costs and then applies carried revenue. This sequence is repeated for each subsequent date in the period.
| Carried Amount ($) | Penalty % | Penalty Amount | Total Carried | Total Penalty | Total Carried + Penalty | Percentage (for revenue calculation) |
|---|---|---|---|---|---|---|
| Prior period balances | 495.66 | 454.34 | 950 | |||
| 130 (asset) | 150% | 65 | 625.66 | 519.34 | 1145 | |
| 250 (expense) | 200% | 250 | 875.66 | 769.34 | 1645 | 0.467683890577508 |
| -40 (revenue) |
(-21.29) 854.37 |
(-18.71) 750.63 |
1605 |
0.467682242990654 |
||
| -40 (revenue) |
(-21.29) 833.08 |
(-18.71) 731.92 |
1565 |
0.467680511182109 |
||
The July balances include the June ending balances plus new carried costs, penalties, and revenue.
The balances continue to increase compared to June, indicating that carried costs and penalties still exceed carried revenue. As a result, payout has not yet been reached.
| Carried Amount ($) | Penalty % | Penalty Amount | Total Carried | Total Penalty | Total Carried + Penalty | Percentage (for revenue calculation) |
|---|---|---|---|---|---|---|
| Prior period balances | 833.08 | 731.92 | 1565 | |||
| 100 (asset) | 150% | 50 | 933.08 | 781.92 | 1715 | |
| 100 (expense) | 200% | 100 | 1033.08 | 881.92 | 1915 | 0.460532637075718 |
| -3000 (revenue 8/14/2022) |
(-1680.40) -585.32 |
(-1381.60) -499.68 |
-1085 |
0.460534562211982 |
||
The revenue from the 8/14/2022 transaction was allocated across the balances, resulting in total carried revenue exceeding total carried costs and penalties. Consequently, the payout threshold was met, and the excess amount of $1,085 is payable to the nonconsenting stakeholder.
When all nonconsenting stakeholders have reached payout, Joint Venture Management automatically sets the status of the carried interest agreement to Payout Occurred. It also sets the end date of the following configurations to 8/14/2022:
- Carried interest agreement
- Stakeholder group
-
Carried interest ownership definition
The status of the carried interest ownership definition status is changed to Inactive. If this ownership definition is the default ownership definition for the joint venture, you must update the joint venture with a new default ownership definition, typically the source ownership definition associated with the carried interest ownership definition. Also, the carried interest ownership definition is updated with the “Payout occurred” change reason.
In a typical carried interest scenario, it would take several months or even years to generate enough revenue to reach payout.
In some carried interest agreements, payout might occur for only a subset of stakeholder pairs while other stakeholder pairs remain active under different penalty definitions. To continue processing for stakeholder pairs that haven’t reached payout, you must create a new stakeholder group and carried interest ownership definition for the remaining stakeholder pairs. For more information about a partial payout scenario, see Create Penalty Definitions.