7.2 Definition of a Joint Venture
ASC 323-10 — Glossary
Corporate Joint Venture
A corporation owned and operated by a small group of entities (the joint venturers) as a separate and specific business or project for the mutual benefit of the members of the group. A government may also be a member of the group. The purpose of a corporate joint venture frequently is to share risks and rewards in developing a new market, product or technology; to combine complementary technological knowledge; or to pool resources in developing production or other facilities. A corporate joint venture also usually provides an arrangement under which each joint venturer may participate, directly or indirectly, in the overall management of the joint venture. Joint venturers thus have an interest or relationship other than as passive investors. An entity that is a subsidiary of one of the joint venturers is not a corporate joint venture. The ownership of a corporate joint venture seldom changes, and its stock is usually not traded publicly. A noncontrolling interest held by public ownership, however, does not preclude a corporation from being a corporate joint venture.
ASC 805-10 — SEC Materials — SEC Staff Guidance
SEC Observer Comment: Accounting by a Joint Venture for Businesses Received at Its Formation
S99-8 The following is the text
of SEC Observer Comment: Accounting by a Joint Venture for
Businesses Received at Its Formation.
The SEC staff will
object to a conclusion that did not result in the
application of Topic 805 to transactions in which businesses
are contributed to a newly formed, jointly controlled entity
if that entity is not a joint venture. The SEC staff also
would object to a conclusion that joint control is the only
defining characteristic of a joint venture.
ASC 845-10 — SEC Materials — SEC Staff Guidance
SEC Observer Comment: Accounting by a Joint Venture for Businesses Received at
Its Formation
S99-2 The following is the text
of SEC Observer Comment: Accounting by a Joint Venture for
Businesses Received at Its Formation.
The SEC staff will
object to a conclusion that did not result in the
application of Topic 805 to transactions in which businesses
are contributed to a newly formed, jointly controlled entity
if that entity is not a joint venture. The SEC staff also
would object to a conclusion that joint control is the only
defining characteristic of a joint venture.
The ASC master glossary defines corporate joint venture2 and provides specific characteristics of a joint venture within that definition. In addition to those characteristics, there is a consensus that venturers must have joint control over an entity for it to be considered a joint venture, as indicated by the codified comments from the SEC staff observer captured originally in EITF Issue 98-4. Further, the Accounting Standards Executive Committee
(AcSEC) indicated in the advisory conclusion of its AICPA Issues Paper, “Joint
Venture Accounting,” issued July 17, 1979, that the element of “joint control” of
major decisions should be the central distinguishing characteristic of a joint
venture. The AcSEC recommended that the definition in Section 3055 of the Canadian
Institute of Chartered Accountants Handbook (subsequently amended) be adopted in
substance as the definition of a joint venture. The Handbook defines a joint venture
as:
An arrangement 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
on the circumstances. A distinctive feature of a joint venture is that the
relationship between the venturers is governed by an agreement (usually in
writing) which establishes joint control. 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 is in a position to
unilaterally control the venture. This feature of joint control distinguishes
investments in joint ventures from investments in other enterprises where
control of decisions is related to the proportion of voting interest
held.
Although joint control is a joint venture’s most distinguishing feature, it is
not the only characteristic of a joint venture, and as described in ASC
805-10-S99-8 and ASC 845-10-S99-2, the SEC staff “would object to a conclusion that
joint control is the only defining characteristic of a joint venture.”
On the basis of the definition of a joint venture in ASC 323-10-20, we believe
that a joint venture has all3 the following characteristics:
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It is a separate legal entity (see Section 7.2.1).
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It is owned by a small group of entities (see Section 7.2.2).
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Its operations are for the mutual benefit of the members (venturers) (see Section 7.2.3).
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Its purpose is to share risks and rewards in developing a new market, product, or technology; to combine complementary technological knowledge; or to pool resources in developing production or other facilities (see Section 7.2.4).
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It allows each venturer to participate, directly or indirectly, in the overall management. The members have an interest or relationship other than that of passive investors (see Section 7.2.5).
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It is not a subsidiary of one of the members (commonly referred to as the “joint control” provision) (see Section 7.2.6).
The decision tree below illustrates how an
investor should determine whether an entity is a joint venture.
7.2.1 Separate Legal Entity
ASC 323-30
15-3 Although Subtopic 323-10 applies only to investments in common stock of corporations and does not
cover investments in partnerships and unincorporated joint ventures (also called undivided interests in
ventures), many of the provisions of that Subtopic would be appropriate in accounting for investments in these
unincorporated entities as discussed within this Subtopic.
ASC 810-10 — Glossary
Legal Entity
Any legal structure used to conduct activities or to hold assets. Some examples of such structures are
corporations, partnerships, limited liability companies, grantor trusts, and other trusts.
One of the characteristics in the definition of a joint venture is that the venture must be a separate
entity. Further, we believe that the joint venture must be a separate legal entity because it is important
that the entity have a separate legal identity from that of its venturers. This is the foundation for the
ability of all venturers to participate in the entity’s decision making. See Section 3.2 of Deloitte’s Consolidation Roadmap for further information regarding
the evaluation of legal entities. If the venture is not formed as a separate legal entity, it may be a
collaborative arrangement as defined by ASC 808.
Even though ASC 323-10-20 defines a corporate joint venture, other unincorporated legal entities (e.g.,
partnerships) may also be joint ventures. As described in ASC 323-30-15-3, many of the same principles
used in the evaluation of a corporate joint venture would apply to the evaluations of these other
unincorporated entities.
7.2.2 Small Group of Entities
While ASC 323-10-20 prescribes that a joint venture must be owned by a small group of entities, there is
no indication in U.S. GAAP of the maximum number of entities that may own a joint venture. We believe
that in practical terms, the greater the number of investors, the less likely it is for an entity to be jointly
controlled by its venturers. We also believe that the greater the number of investors, the less likely it is
that the entity may meet the condition of being owned by a small group of entities and therefore, the
less likely it is to qualify as a joint venture.
ASC 323-10-20 does allow a joint venture to have a noncontrolling interest held by public investors (both
public entities and individual shareholders). It is not uncommon, nor is it prohibited by U.S. GAAP, for
public entities to be venturers in a joint venture. It is less common for numerous individual shareholders
to hold interests in the joint venture. Typically, when individual shareholders have an interest in a
joint venture, these interests are not significant to those of the other venturers, and the individual
shareholders cannot substantively participate in the financial and operating decisions made in the
ordinary course of business for the joint venture. In these circumstances, a legal entity is not precluded
from meeting the definition of a joint venture should the remaining venturers jointly control the legal
entity.
7.2.3 Mutual Benefit of Members (Venturers)
The joint venture’s operations must be for the mutual benefit of its members. The members, however,
do not need to benefit equally for the entity to be a joint venture. In fact, one venturer may receive
substantially all of the benefit and the entity may still be a joint venture.
7.2.4 Purpose
Under ASC 323-10-20, the “purpose of a corporate joint venture frequently is to
share risks and rewards in developing a new market, product or technology; to
combine complementary technological knowledge; or to pool resources in
developing production or other facilities.”
At the 2014 AICPA Conference on Current SEC and PCAOB Developments, Chris
Rogers, then a professional accounting fellow in the SEC’s OCA, commented on the
evaluation of the purpose of a joint venture and stated, in part:
In evaluating joint venture formation transactions, the
staff continues to believe that joint control is not the only defining
characteristic of a joint venture. Rather, each of the characteristics in
the definition of a joint venture in Topic 323 should be met for an entity
to be a joint venture, including that the “purpose” of the entity is
consistent with that of a joint venture. . . .
The
staff has seen recent fact patterns where the primary purpose of a
transaction is to combine two or more existing operating businesses in an
effort to generate synergies such as economics of scale or cost reductions
and/or to generate future growth opportunities. In these fact patterns,
determining whether the purpose of the transaction is consistent with the
definition of a joint venture as described in Topic 323 or whether the
substance of the formation transaction is a merger or put together
transaction that should be accounted for as a business combination under
Topic 805 requires a significant amount of judgment. [Footnotes
omitted]
As emphasized by Mr. Rogers, the “purpose” criterion is one of the defining characteristics of a joint venture. Many transactions that may be viewed as potential joint ventures do not meet the definition of a joint venture because the purpose of the venture is only to generate synergies, such as economies of scale or cost reductions, or to generate future growth opportunities of two merged companies. This does not mean that a venture that will create synergies is precluded from meeting the definition of a joint venture but that a venture that is created solely to combine existing businesses or to function as an extension of the investors’ ongoing operations would not meet the purpose criterion. Instead, a venture must focus on the development of something new and different to satisfy the purpose criterion (e.g., the combination of technological knowledge to achieve a new commercial purpose or business objective). This criterion may be challenging for an entity to assess.
Example 7-1
Company A has a subsidiary, Entity C, that sells outdoor equipment. Entity C meets the definition of a business. Company A approached a private equity firm, Company B, to invest in C. To effect the transaction, A formed a new entity, NewCo, and contributed C. Company B contributed its cash investment in exchange for an ownership interest of 50 percent in NewCo.
NewCo is not a joint venture because it does not meet the purpose criterion in the term’s definition. That is, NewCo is not developing a new market, product, or technology; combining complementary technological knowledge; or pooling resources in developing production or other facilities.
Example 7-2
Company A has developed a new product, SW. To expand its manufacturing
capabilities for this new product, A and a private
equity firm, PE 1, form a legal entity (NewCo) whereby A
will contribute its IP for SW as well as facilities in
which SW will be manufactured, and A will transfer
employees to manufacture SW. PE 1 will contribute cash
that NewCo will use to expand its manufacturing
capacity. Company A and PE 1 jointly control all
decisions that affect NewCo’s economic performance and
share equally in its profits and losses. Company A will
distribute SW within its distribution channels.
NewCo is not a joint venture because it does not meet the purpose criterion in the term’s definition. While NewCo is manufacturing a new product, A (instead of NewCo) developed it. Further, NewCo is not developing a new market but will employ A’s distribution channels. PE 1 is not combining complementary technological knowledge; nor will its contributed cash be used to develop new technology, production, or facilities.
Example 7-3
Company X is a business that explores for, develops, and drills for oil and natural gas assets in Alaska. Company
X is highly leveraged and is not cash flow positive and therefore desires to more readily access the capital
markets. Company Y is a multinational conglomerate that owns a diverse portfolio of businesses, including
drilling equipment. Company Y’s drilling business is cash flow positive. Both companies contribute their
respective businesses into a new legal entity, Entity OG, resulting in operational synergies. Companies X and Y
jointly control all decisions that affect OG’s economic performance of OG and share equally in its profits and
losses.
While the resulting operational synergies do not preclude OG from meeting the definition of a joint venture,
it is not a joint venture because it does not meet the purpose criterion in the term’s definition. Companies X
and Y are combining their businesses with the purpose of more readily accessing capital markets and will not
be developing a new market, product, or technology; combining complementary technological knowledge; or
pooling resources in developing production or other facilities.
7.2.5 Management of the Entity
Venturers in a joint venture must be able to participate in its management. The term’s definition allows
for this participation to be direct or indirect. That is, each venturer could but is not required to serve
as a member of management and carry out the day-to-day operations. If venturers instead appoint
a management team, they should be able to substantively participate in the appointment, oversight,
and termination of team members, in addition to the setting and adjustment of their compensation as
well as other financial and operating decisions made in the joint venture’s ordinary course of business.
Further, the venturers must not convey to management any power to make significant decisions that
affect the venture. See Section 7.2.6.2 for an evaluation of management teams.
To participate indirectly in the joint venture’s management, the venturers should make its significant
financial and operating decisions (e.g., approving operating and capital budgets as well as selecting,
terminating, and setting the compensation of management team members) that occur in the
ordinary course of business, and management should be able to only carry out these decisions (e.g.,
implementing the venturer-approved operating and capital budgets) and not significantly deviate from
them.
7.2.6 Joint Control
Joint control is the most distinguishing characteristic of a joint venture. Even though the definition of a
joint venture in ASC 323-10-20 specifies only that it cannot be a subsidiary of one of the venturers (see
the discussion in Section 7.2.6.1 regarding considerations of whether an investor would consolidate
a VIE and voting interest entity, respectively), on the basis of guidance from the SEC, a joint venture
must be jointly controlled by its venturers. This distinction is significant since it may be possible for the
investors to be precluded from consolidating a legal entity without jointly controlling it.
The ASC master glossary defines joint control as “decisions regarding the financing, development,
sale, or operations [that] require the approval of two or more of the owners.” Likewise, the G4+1
Organization Special Report Reporting Interests in Joint Ventures and Similar Arrangements may be
helpful in the determination of the presence of joint control. Paragraph 2.14 of the Special Report states,
in part:
Joint control over an enterprise exists when no one party alone has the power to control its strategic operating,
investing, and financing decisions, but two or more parties together can do so, and each of the parties sharing
control (joint venturers) must consent.
Example 7-4
Investor A, Investor B, and Investor C form a venture, Entity Z. All decisions that significantly affect Z are made by a simple majority vote of Z’s board of directors. All three investors may appoint one director. Entity Z is not jointly controlled by the three investors because each decision does not require the consent of all the investors. That is, a decision may be made with the vote of two of the investors.
Connecting the Dots
An investor evaluating whether there is joint control over an entity must consider each investor’s rights in case the investors cannot reach a unanimous decision (i.e., a deadlock). These tiebreaker terms and conditions and an understanding of who has the authority to make decisions if there is a deadlock may prove critical in the determination of whether the investors jointly control the venture. For the venture to be jointly controlled, no investor can have the unilateral ability to cast a deciding vote in the event of deadlock. Consider the following example:
Investor RK and Investor JK form Company PN. All decisions that significantly affect the company require unanimous consent from both investors. In case of a deadlock, the matter is taken to an arbitration court in which each investor may elect one arbiter, and those two arbiters will elect the third. The arbitration court will rule on the matter with a simple majority, and the ruling will be accepted by both RK and JK.
In this example, neither investor has the unilateral ability to break the deadlock, and therefore, PN is jointly controlled.
7.2.6.1 Variable Interest Entity and Voting Interest Entity Models
In determining whether a reporting entity and other investors jointly control a
legal entity, the reporting entity must first consider which consolidation
model — the “VIE model” or the voting interest entity model (“voting model”)
— is applicable. ASC 810-10 requires the reporting entity to first determine
whether the legal entity is a VIE. Should the reporting entity determine
that the legal entity is a VIE, it would apply the VIE model to determine
whether the reporting entity has a controlling financial interest.
Conversely, should the reporting entity determine that the legal entity is
not a VIE, it would apply the voting model to ensure that the reporting
entity does not have a controlling financial interest.
As discussed in further detail below, there are some significant differences in the analysis of control under these respective models (see Section 1.4 of Deloitte’s Consolidation Roadmap for a more complete comparison).
7.2.6.1.1 VIE Model
In accordance with ASC 810-10-25-38A, a reporting entity has control over a VIE
if it has both “[t]he power to direct the activities of a VIE that most
significantly impact the VIE’s economic performance” and “[t]he
obligation to absorb losses of the VIE that could potentially be
significant to the VIE or the right to receive benefits from the VIE
that could potentially be significant to the VIE.” To determine whether
the investors jointly control the VIE, the reporting entity would
perform the following steps:
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Step 1 — Evaluate the purpose and design of the VIE and the risks the VIE was designed to create and pass along to its variable interest holders.
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Step 2 — Identify the significant decisions related to the risks identified in step 1 and the activities associated with those risks.
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Step 3 — Identify the party that makes the significant decisions or controls the activity or activities that most significantly affect the VIE’s economic performance.
If each of the investors shares in making all decisions over the activities that most significantly affect the
VIE’s economic performance, the investors would jointly control the VIE.
For more information on the power to direct the most significant activities and the VIE model, see
Chapter 7 of Deloitte’s Consolidation Roadmap.
7.2.6.1.2 Voting Model
ASC 810-10-15-8 and 15-8A indicate that an investor with a majority voting interest or a limited partner
with a majority of kick-out rights through voting interests will generally control a legal entity. However,
ASC 810-10-15-8 and 15-8A also provide exceptions to this guidance and indicate that the power to
control may also exist with a lesser percentage of ownership (e.g., by contract, lease, agreement with
other owners of voting interests, or court decree). Therefore, conclusions about control should be based
on an evaluation of the specific facts and circumstances. In some situations, an investor with less than
a majority voting interest or a limited partner with less than a majority of kick-out rights can control a
legal entity. In other situations, the power of a stockholder with a majority voting interest or of a limited
partner with a majority of kick-out rights to control a legal entity does not exist with the majority owner
because of noncontrolling rights or as a result of other factors. The majority investor may be precluded
from controlling the legal entity when another investor has the ability to veto or substantively participate
in the legal entity’s significant decisions.
We believe that for the legal entity to qualify as a joint venture, each
venturer should substantively participate in all the legal entity’s
significant decisions. If one or more, but not all, of the investors
have the ability to unilaterally perform the following actions outlined
in ASC 810-10-25-11, the investors do not jointly control the legal entity:
- ”Selecting, terminating, and setting the compensation of management responsible for implementing the investee’s policies and procedures.”
- ”Establishing operating and capital decisions of the investee, including budgets, in the ordinary course of business.”
The following conditions may indicate that the investors do not jointly control the legal entity should one
or more, but not all, of the investors:
- Hold the majority of total equity or otherwise provide additional financial support to the legal entity (e.g., one investor guarantees the legal entity’s debt), thereby resulting in potential influence beyond voting share percentage.
- Have the ability to unilaterally sell, lease, or otherwise dispose of the legal entity’s assets or to unilaterally enter into contracts or commitments on the legal entity’s behalf.
In summary, we believe that to jointly control a legal entity, all investors must participate in the legal
entity’s significant decisions. To the extent that an investor has little or no influence, the investors would
not jointly control the legal entity.
However, in the evaluation of whether joint control exists, the
likelihood of an entity to exercise its rights would not be considered
as part of the analysis. Instead, joint control exists when all of the
owners have, at a minimum, the ability to effectively participate in the
significant decisions of an entity regardless of the investor’s intent
to act on this ability.
For more information on the voting model, see Appendix D of Deloitte’s Consolidation Roadmap.
Example 7-5
Company A and Company B form a venture, Entity Z, that is a voting interest entity under ASC 810. Entity Z’s significant operating and capital decisions are made by a simple majority vote of its board of directors. Company A may appoint three directors, while B may appoint only two. However, B has a consent right for the appointment, termination, and determination of the compensation of Z’s management.
Company B’s consent right for Z’s management is a substantive participating right and would preclude A from consolidating Z. However, B does not have the ability to jointly participate in the remaining operating and capital decisions that are significant to Z, and therefore Z is not jointly controlled by A and B.
7.2.6.1.3 Other Differences Between the VIE and Voting Models
7.2.6.1.3.1 Forward Starting Rights and Potential Voting Rights and Contingencies
Future decision making and control can be conveyed to a venture through potential voting rights, in some cases referred to as forward starting rights (such as call options and put options conveyed in accordance with contracts in existence as of the balance sheet date), or through the occurrence of a contingent event.
7.2.6.1.3.1.1 VIE Model
In the VIE model, while the existence of such
rights, in isolation, may not be determinative in the
identification of the party (or parties) with power over the
activities that most significantly affect the VIE’s economic
performance, such rights often help a reporting entity
understand the purpose and design of a legal entity. Therefore,
potential voting rights are considered in the determination of
whether the reporting entity and other investors jointly control
the VIE. In addition, forward starting rights as a result of a
contingent event should be evaluated in the determination of
whether the contingency initiates or results in a change in
power and, for the latter, whether the contingency is
substantive. For example, a venture may be created to construct
a power plant (i.e., the construction phase) and to subsequently
provide power to customers (i.e., the operations phase).
Sometimes venturers will create these multiphased ventures with
different parties governing and making decisions for each phase.
We believe that the venturers must jointly control the joint
venture during each of these phases.
7.2.6.1.3.1.2 Voting Model
In the voting model, potential voting rights,
whether forward starting or conveyed upon the resolution of
contingency, are not considered in the analysis of which entity
has a controlling financial interest unless they are deemed to
be held because of a nonsubstantive exercise or purchase price
(i.e., a reporting entity can obtain these voting rights at
little or no economic cost) and there are no significant
decisions in the ordinary course of business that will be made
before the potential voting rights are exercisable. A reporting
entity must use significant judgment and evaluate all relevant
facts and circumstances to determine whether the purchase price
is nonsubstantive.
Example 7-6
Investor A and Investor B form
a joint venture and each own equity and voting
interests of 50 percent. All decisions that most
significantly affect the venture are made by a
unanimous vote of the shareholders. Investor A has
the ability to call 10 percent of B’s ownership
interests for a fixed price. Even though the call
option would convey an additional 10 percent
voting interest to A, the legal entity’s
governance still requires the unanimous vote of
both investors to make the joint venture’s
significant decisions. Therefore, the venture
would be under joint control regardless of the
substance of the call option, which would change
only the economic ownership percentage rather than
the governance to control.
However, if the decisions that
most significantly affect the venture were made by
a simple majority vote of shareholders, careful
consideration should be given to the evaluation of
the call option. If the fixed-price call option is
exercisable by A at little or no economic cost,
there would not be a significant barrier to A’s
exercising the option, and therefore A and B would
not jointly control the venture.
7.2.6.1.3.2 Related Parties
7.2.6.1.3.2.1 VIE Model
In the VIE model, a reporting entity should evaluate which entity has control of
a legal entity when the reporting entity’s related parties are
involved with the VIE. If investors are related parties and
share power over a VIE, one of the investors must consolidate
the VIE. Because a legal entity cannot meet the definition of a
joint venture if one party consolidates the legal entity,
neither investor would be able to conclude that the legal entity
is a joint venture despite the fact that there is joint control
over the most significant activities.
ASC 850-10-20 defines “related parties,” and the VIE model expands the population of entities that are
considered related parties for VIE analysis purposes. Specifically, ASC 810 identified certain relationships
that may indicate that one party (the “de facto agent”) may be acting on behalf of another (the “de facto
principal”).
In practice, joint venture arrangements frequently have transfer restrictions on
when each venturer can sell its investment. A potential de facto
agency relationship may exist when the transfer restrictions are
not mutual (e.g., when one venturer can sell its interest
whereas the other venturer must receive approval from the other
venturer to sell its interest). However, the existence of
transfer restrictions does not always result in a de facto
agency relationship as indicated in ASC 810-10-25-43(d), which
states, in part, that “a de facto agency relationship does not
exist if both the reporting entity and the party have right of
prior approval and the rights are based on mutually agreed terms
by willing, independent parties.”
See ASC 810-10-25-43 for the various de facto agents identified by the FASB and Section 8.2.3 of
Deloitte’s Consolidation Roadmap for more information.
7.2.6.1.3.2.2 Voting Model
In the voting model, related parties — both related parties defined in ASC 850-10-20 and de facto
agents — are not considered.
7.2.6.2 Decisions Made by Different Governing Parties
Assessing whether the power criterion has been met can be more complex when decisions are made
by different parties and at different governance levels. In some arrangements, certain decisions could
be made directly by the investors, a board of directors established for the venture, or the venture’s
management. It is important for an entity to identify which party or parties make the venture’s significant
decisions and whether one or more, but not all, of the investors may unilaterally make those decisions
when the entity is determining whether the investors jointly control the venture. Each venturer may or
may not appoint an equal number of directors to the board or members of management. However, the
venturers may jointly control the venture as long as each venturer equally participates in the venture’s
significant decisions through the venturer’s representation on the board or in management. That
is, significant decisions must require the consent of each of the venturers (or their delegates on the
management team) for the venture to qualify as a joint venture. See Section 7.2.6.1 on the evaluation of
control in both the VIE and voting models.
Example 7-7
Two unrelated investors, Company R and Company S, form an LLC by contributing equal amounts of cash for equity ownership interest of 50 percent each. Profits and losses are shared equally. The investors have delegated the LLC’s management to a four-member management committee to which each investor appoints two representatives.
Decisions regarding the LLC’s ongoing operations require a majority vote of the management committee. The venturers can remove a member of the management committee only for cause. The LLC’s governing documents state that there must always be equal representation of both venturers on the management committee.
While the right to make day-to-day decisions has been assigned to a management committee, the LLC is still governed and jointly controlled by the venturers because decisions made in the ordinary course of business require the consent of at least one representative from each of the venturers. That is, the representatives from R are required to obtain at least one vote from the representatives from S, and vice versa, to move forward with a decision that affects the LLC’s ongoing operations.
7.2.6.3 Unequal Ownership
In both the VIE and voting models, a reporting entity that has a majority ownership interest in a legal entity may not have a controlling financial interest in that entity. Similarly, venturers may have varying degrees of ownership interests in the joint venture and are not required to have equal ownership interests to jointly control the legal entity.
Further, the existence of a publicly held noncontrolling interest does not
preclude an entity from meeting the definition of a joint venture for GAAP
purposes. Publicly held noncontrolling interests are believed to be passive,
meaning that public noncontrolling interest holders are unlikely to be able
to participate substantively in the decision-making related to the legal
entity.
Example 7-8
Company B and Company C enter into a joint venture arrangement (forming Entity D) that enables B to gain access to C’s technology and enables C to gain access to B’s production and distribution network. The equity interests and profit/loss allocation under the arrangement is 60:40 to B and C, respectively. While B has majority ownership, the joint venture agreement provides that all significant decisions involving the joint venture’s activities require unanimous approval of both B and C.
The ownership interests do not have to be split equally among the venturers for joint control to exist. Because the joint venture agreement provides that all significant decisions involving D’s activities require unanimous approval of both venturers, neither one is able to unilaterally control D. As long as no conditions exist that indicate substantive control of D by either B or C, joint control would exist between the venturers. While C does not have equal ownership to B, C is in a position to veto actions proposed by B only by exercising its participating rights. In substance, this is equivalent to equal ownership between the venturers, a situation that would also require unanimous approval of both venturers.
7.2.7 Reassessment of the Joint Venture Determination
The determination of whether a reporting entity should consolidate a legal entity is a continual process. That is, as facts and circumstances change, a reporting entity may obtain (or lose) a controlling financial interest in a legal entity. As a result, a previous conclusion that a legal entity is a joint venture may change. Accordingly, upon a change in facts and circumstances, a venturer should determine whether its previous conclusions regarding the characteristics of a joint venture have changed. For example, a change in the venturer’s participation in the joint venture’s significant decisions may indicate that the venturer’s conclusion regarding this characteristic of a joint venture is no longer appropriate. In addition, if the joint venture has been determined to be a VIE, a change in this determination or change in the reporting entity’s related parties may require the venturer to reevaluate its conclusion that the legal entity is a joint venture.
Changing Lanes
ASU 2023-05 defines the formation date of a joint
venture as “the date on which an entity initially meets the definition
of a joint venture, which is not necessarily the legal entity formation
date.” To meet that definition, the conditions described throughout this
chapter need to be met. Paragraph BC39 of the ASU explains that “joint
venture formation is the date that a joint venture uses to initially
measure its net assets in its separate financial statements, similar to
the acquisition date in a business combination.” The FASB considered
whether control and the purpose of the entity should be considered in
the determination of the formation date. However, as stated in paragraph
BC43 of the ASU, because the Board was “concerned that incorporating the
concepts of control and purpose would increase the subjectivity of
interpreting the definition and add undue complexity,” it ultimately
“decided on a simplified definition of formation date to avoid diversity
in practice.”
Given the significance of the formation date for joint ventures, we
believe that the determination of whether a legal entity meets the GAAP
definition of a joint venture or corporate joint venture may need to be
reassessed as facts change. See Chapter
9 for further discussion.
Footnotes
2
We have used the terms “corporate joint venture” and “joint
venture” interchangeably in this publication.
3
The requirement that all the conditions must be met is
consistent with the views
expressed by then SEC Professional Accounting Fellow
Chris Rogers at the 2014 AICPA Conference on Current SEC and PCAOB
Developments. See Section
7.2.4 for excerpts from the remarks.