IN BRIEF
ASU 2023-05 addresses the accounting by a joint venture for the initial contribution of nonmonetary and monetary assets to the undertaking. This article discusses the underlying principle that JVs recognize contributed net assets at fair value initially and apply a new basis of accounting for the newly formed entity. Three common scenarios are described to illustrate the implications of the standard after a JV’s formation and when it might no longer qualify as a JV and other guidance applies.
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In August 2023, FASB issued ASU 2023-05, Business Combinations–Joint Venture Formation: Recognition and Initial Measurement, codified under ASC Subtopic 805-60. This ASU addresses the accounting by a joint venture (JV) for the initial contribution of nonmonetary and monetary assets to the venture. Joint ventures formed on or after Jan. 1, 2025, are required to adopt this ASU, with early adoption permitted.
Joint ventures are arrangements whereby two or more parties (the venturers) jointly control a specific business undertaking and contribute resources towards its accomplishment. The life of the joint venture is limited to that of the undertaking, which may be of short or long-term duration, depending upon the circumstances.
The ASU requires joint ventures, upon formation, to 1) recognize and measure the initial contributions of monetary and nonmonetary assets by the venturers at fair value and 2) measure its net assets (including goodwill) at fair value by using the fair value of the joint venture as a whole. Therefore, upon adopting ASU 2023-05, a JV will measure its total net assets as the fair value of 100% of its equity immediately after formation.
This article expounds on the principles of joint venture accounting upon their formation and in subsequent periods. In particular, it discusses the underlying principle that JVs recognize contributed net assets at fair value initially and apply a new basis of accounting for the newly formed entity. The article provides three examples that reflect the scenarios companies encounter after adopting ASU 2023-05.
Background
ASC 323, Investments—Equity Method and Joint Ventures, defines a corporate joint venture as a corporate-owned entity that a small group of joint venturers own and operate for a specific business purpose and their mutual benefit. A corporate JV usually provides an arrangement under which each of the joint venturers may participate, directly or indirectly, in the overall management of the joint venture. Therefore, venturers are not passive investors.
A distinctive feature of a joint venture is that an agreement (usually in writing) establishing joint control governs the relationship between the venturers. Decisions in all areas essential to the accomplishment of a joint venture require the consent of the venturers, as provided by the agreement; none of the individual venturers can unilaterally control the venture. This feature of joint control distinguishes investments in joint ventures from investments in other enterprises where control is related to the proportion of voting interest held. Thus, a corporate JV is a corporation owned and operated by a small group of entities (the joint venturers) as a separate business for the mutual benefit of the group members.
The definition of a JV does not include investments in unincorporated joint ventures (including partnerships); however, ASC 323-30 concludes that many of the provisions of this guidance are also appropriate in assessing investments in unincorporated joint ventures. Therefore, in practice, joint venture accounting is not restricted by the type or legal form of the entity.
Objectives
FASB issued this ASU because of the absence of guidance on the recognition and measurement of the contribution of nonmonetary and monetary assets in a JV’s stand-alone financial statements. While the ASU does not change the definition of a joint venture, a new basis of accounting is established upon the venture’s formation.
The ASU has the following dual objectives:
- To provide decision-useful information to the users of a joint venture’s financial statements.
- To reduce diversity in practice around how a JV or corporate JV accounts for the contributions it receives from its venturers upon formation.
Asset Purchase Accounting
Joint venture accounting differs from “asset purchase accounting. The following is an excerpt from an article that the author published in the January/February 2022 CPA Journal, “Asset Acquisition Accounting, Understanding the Available Guidance”:
A business combination is a transaction or event by which an acquirer obtains control of a business (i.e., the acquiree). If the acquisition of an asset or asset group (including liabilities assumed) does not constitute a business, however, the transaction is no longer a business combination and the acquirer accounts for it as an “asset acquisition.” An asset acquisition transaction uses a cost accumulation model, whereas a business combination within the scope of ASC 805, “Business Combinations,” uses a fair value model (https://www.cpajournal.com/2022/04/04/asset-acquisition-accounting).
Collaboration
Joint ventures are not collaborative arrangements, where they aim to provide partners with a share of profits and losses in joint operating activities. In collaborative arrangements, partners usually share responsibilities, but one partner may be responsible for specific activities while others share the remaining responsibilities. Counterparties in a collaborative arrangement often conduct their activities without the creation of a separate legal entity. As a result, collaborative arrangements usually provide a certain level of flexibility and less structure in their operations. Collaborative arrangements are typically within the scope of ASC Topic 808, Collaborative Arrangements.
Goodwill
ASC Topic 350, Intangibles–Goodwill and Other, defines goodwill as “an asset representing the future economic benefits arising from other assets acquired in a business combination that are not individually identified and separately recognized.” In other words, goodwill is the excess amount that an acquirer is willing to pay over the fair value of the acquired reporting unit (acquiree) from the perspective of an appropriate market participant. Companies often refer to “increased synergies” in business combinations to justify the amount of goodwill paid in excess of fair value.
In a transaction for the formation of a JV, the unit of accounting is usually the JV. But goodwill and its amortization and impairment impact the venturers’ investment and earnings accounts. JVs are often private enterprises, and they can amortize goodwill on a straight-line basis over the shorter of its useful life or 10 years (ASC 350-20-35-63). Nevertheless, JVs usually follow the policies of their venturers for amortization or impairment testing of goodwill.
The author published an article on this subject in the September 2018 CPA Journal, “The New Guidance for Goodwill Impairment” (https://www.cpajournal.com/2018/09/26/the-new-guidance-for-goodwill-impairment). This article provided an overview of the goodwill impairment assessment under the new guidance and some specific income tax considerations regarding the financial implications of goodwill impairment.
JVs do not meet the definition of business combinations under ASC 805; however, they may recognize goodwill. JVs recognize goodwill upon formation based on the excess of:
- The formation-date fair value of the JV as a whole, which equals the fair value of 100% of the JV’s equity (net assets) immediately following formation, including any non-controlling interest (NCI) in the net assets recognized by the JV, over
- The net amount of the formation-date identifiable assets and liabilities that JVs have recognized (ASC 805-20).
The initial measurement of a JV’s basis under the new guidance has similarities with pushdown accounting, where the acquirer pushes down a new basis for assets and liabilities to the acquiree. For example, JVs do not recognize negative goodwill as a bargain purchase gain, as in a business combination, but rather as an adjustment to equity.
The following is an excerpt from an article that the author published in the March/April 2023 CPA Journal, “Insights into Pushdown Accounting”:
When an acquirer obtains control of a business, it establishes new bases for the assets acquired and liabilities assumed based on their fair values. The acquiree can adopt the acquirer’s recognized new bases (the stepped-up basis) in its financial statements. Thus, the process whereby an acquirer pushes down the fair values of the acquired assets and assumed liabilities to an acquiree’s financial statements is called “pushdown accounting” (https://www.cpajournal.com/2023/06/07/insights-into-push-down-accounting).
Other Assets and Liabilities
JVs capitalize as indefinite-lived intangible assets all in-process intangible research and development assets (IPR&D) that venturers have contributed at its formation, consistent with the accounting model for business combinations (ASC 805).
Joint venturers may contribute one or more businesses to the JV that have employees with share-based payment awards. In these situations, the JV must determine which portion of the compensation expense associated with those awards should be attributed to the employees’ pre-formation and post-formation services based on ASC 718 (Compensation—Stock Compensation) as equity or liability. JVs account for pre-formation vested awards as additional paid-in capital (APIC), or other similar equity account. JVs account for the fair value of contingent considerations as a liability (or asset) at their formation.
Joint Control
The most distinctive characteristic of a joint venture is the concept of joint control. The Accounting Standards Executive Committee (AcSEC), in its advisory 1979 Joint Ventures Accounting: Issue Paper, defined JVs as arrangements where-by two or more parties (the venturers) jointly control a business under-taking [para. 51(b); https://tinyurl.com/3dum3de9]. This definition implies that all venturers should consent to any business decisions. The feature of joint control distinguishes joint ventures from investments in other types of entities where control of decisions is related to the proportion of voting interest held by investors. Even though AcSEC’s issue paper is not authoritative guidance, it has been widely adopted and applied in practice.
Equity Method of Accounting
An investment in a joint venture is generally accounted for under the equity method of accounting under ASC Topic 323. If an equity method investee is considered significant to a business that is a public company registered with the SEC, the registrant may be required to provide the investee’s separate financial statements or summarized financial information in the financial statement footnotes (or both). The amount of information a registrant must present depends on the level of significance, which is determined based on the results of various tests outlined in SEC Regulation S-X. The author previously explored this subject in “Equity Method Accounting,” (The CPA Journal, January/February 2023, https://www.cpajournal.com/2023/04/12/equity-method-accounting).
Companies may account for an equity investment using consolidation, equity method, or fair value method. Generally, an investor accounts for an investment as a consolidated subsidiary when it can exercise control over the subsidiary; however, if the acquirer exercises only significant influence over the investee, it uses the equity method of accounting. If an investor exercises neither control nor significant influence over the acquiree, the proper method of accounting for the investor is fair value.
Investors should apply significant judgment and consider both the form and substance of a transaction when determining the appropriate accounting method for their investments. If investors do not control the investee and do not consolidate it, they should evaluate the use of the equity method to account for the investment.
Significant Influence
An investor has significant influence over, but does not control, the investee if the investor holds between 20% and 50% of the voting common stock of an investee and does not exercise any control over the subsidiary. FASB considers a significant influence criterion based on the ownership of outstanding securities whose holders possess voting privileges. If an investor has significant influence over the investee, it must account for its investment under the equity method. Ownership levels as low as 3% may also require the application of the equity method in certain circumstances if the investor exercises significant influence over the investee. The following indicators reflect the ability of an investor to exercise significant influence under ASC 323-10-15-6–11:
- Board of directors’ representation and participation in policy-making processes
- Material intra-entity transactions and technological dependency
- Interchange of managerial personnel and extent of ownership.
There is more guidance regarding application of the equity method to JV accounting elsewhere in ASC Topic 323:
The guidance in the Investments—Equity Method and Joint Ventures Topic applies to investments in common stock or in-substance common stock (or both common stock and in-substance common stock), including investments in common stock of corporate joint ventures (ASC 323-10-15-3).
Investments held in stock of entities other than subsidiaries, namely corporate joint ventures and other noncontrolled entities are accounted for in accordance with either the recognition and measurement guidance in Subtopic 321-10 or the equity method (ASC 323-10-05-4).
Investors in unincorporated entities such as partnerships and other unincorporated joint ventures generally shall account for their investments using the equity method of accounting by analogy to Subtopic 323-10 if the investor has the ability to exercise significant influence over the investee (ASC 323-30-25-1).
Exhibit 1 compares several different forms of business ventures and their respective accounting considerations.
EXHIBIT 1
APC’s Balance Sheet
Basis Difference
The equity method requires investors to record their investments initially at cost (ASC 323-10-30-2 and ASC 805-50-30). An investor, however, may have a “basis difference” between the cost of its investment and the underlying equity in the net assets of an acquired investee. Investors account for the basis differences as adjustments to the bases of the assets acquired, goodwill, and other intangible assets as if the equity method investees were consolidated subsidiaries (ASC 323-10-35-13). Nevertheless, an equity method investment always appears as a single-line item on investors’ balance sheets (i.e., a “one-line consolidation”).
Example. Considering the following scenario: Entities A and B contribute to a JV some of their assets with book values of $10,000 and $15,000, respectively. The fair value of these assets is $25,000 for each entity, for a total of $50,000, and the fair value of the whole JV is $67,000. Entity A recognizes $15,000–the difference between the book value of the assets for $10,000 and its fair value at $25,000. Entity B recognizes $10,000–the difference between the book value of the assets for $15,000 and its fair value at $25,000. The JV recognizes goodwill for $17,000, representing the difference between its whole value of $67,000 and the fair value of the assets contributed for $50,000.
Subsequent Measurements
After the initial measurement at fair value, the carrying amount of an equity method investment may increase or decrease to reflect an investor’s share of earnings or losses in its investment account (ASC 323-10-35-4). An investor typically presents its share of gains or losses from its equity method investment in its income statement and investment account on a single line. It discontinues applying the equity method if the balance of its investment account has declined to zero due to the investee’s losses (ASC 323-10-35-20). The following calculation illustrates how the equity method functions:
- + Initial investment recorded at cost
- +/– Investor’s share of joint venture profit or loss
- – Distributions received from the joint venture
- – Ending investment in joint venture
Illustrative Examples
Example 1. Entities A and B (joint venturers) form a JV, and each contributes cash, PP&E, intellectual property, intangible assets, management, and workforce to the JV. The JV has four board members, and each venturer selects two of the four members. The parent entities take turns choosing the CEO and chairman of the board on a rotating basis. The approval of significant decisions requires a unanimous vote of both venturers. Thus, the parent entities (Entities A and B) have joint control over the JV.
The JV, as a whole, has a fair value of $220,000 (exceeding investors’ contribution of $200,000 by $20,000). The JV accounts for this excess value as goodwill and records it in its books accordingly. As shown in Exhibit 2, the venturers (Entities A and B) account for this transaction based on the equity method of accounting.
EXHIBIT 2
Accounting for Excess Value
Example 2. Assume the same facts as Example 1, but now Entity A maintains a 40% interest, and Entity B maintains the remaining 60% interest. The definition of a joint venture does not require that each investor have an equal ownership interest in the joint venture; thus, venturers A and B can still account for it as a JV.
Example 3. Assume that Entity B makes the same contribution as in Example 1 for a 60% interest in the JV and the election of three of the four board members. Entity A contributes $5,000 in intangible assets and $45,000 PP&E for a 25% interest in the JV and the election of one of four board members. Entity C (an NCI) contributes $50,000 cash for 15% and remains a passive investor. Entity B makes all the significant business decisions and selects the CEO. This scenario is illustrated in Exhibit 3.
EXHIBIT 3
When Consolidation is Required
With the circumstances changed thus, the newly formed company is no longer considered a JV. Entity B consolidates the new company for its 50% interest since it has control. Entity A uses equity method accounting to account for its 25% interest because it has significant interest. Entity C uses the fair value method to account for its 15% interest.
The Implications of Simplification
US GAAP previously stipulated that transactions between a JV and its owners are outside the scope of both ASC 845 and ASC 805; however, its lack of specific accounting guidance on how a JV, upon formation, should recognize and initially measure assets contributed and liabilities assumed, resulted in diversity in practice.
In response, FASB issued ASU 2023-05, which requires JVs, upon formation, to apply a new basis of accounting—similar to pushdown accounting under ASC 805—and to recognize contributed net assets at fair value as of the JV’s formation date. In this author’s opinion, ASU 2023-05 has streamlined and simplified the JV accounting process and is an improvement in GAAP. Furthermore, the new guidance has made the JV accounting consistent with the guidance for business combinations and acquisitions. The new guidance does not change the subsequent measurement and accounting for JVs under the equity method of accounting.
