Chapter 8 — Accounting by the Joint Venture Before Adopting ASU 2023-05

8.2 Initial Contribution of Nonmonetary Assets That Meet the Definition of a Business

8.2.1 Development of Fair Value or Carry-Over Approach for Joint Venture Formation Measurement

Before we discuss the views that may be applied in practice for the contribution of nonmonetary assets that meet the definition of a business, it is important to understand the circumstances in which the two acceptable approaches were developed in the absence of prescriptive FASB guidance.

With respect to joint ventures’ accounting for the contribution of nonmonetary assets upon formation, the SEC periodically provided guidance on joint ventures that influenced the accounting in this area. At the 1992 AICPA Conference on Current SEC Developments, then Professional Accounting Fellow Steve Blowers stated that the SEC staff would continue to scrutinize any step-up in basis for nonmonetary assets contributed to a joint venture and that it would permit a full step-up only if the following criteria were met:

Contribution of the asset or business was to a new entity.
The fair value was objectively determinable and supported by equal contributions of monetary assets by the other investor(s).
The monetary assets must have stayed in the new venture or been used for transactions with parties other than the venturers.
There was an equal allocation of equity and profits or losses between the venturers.
The new entity was clearly a joint venture; control was shared in meaningful respects (board of directors, shareholder interests, and so forth).

Because it is difficult to meet these criteria, many joint ventures have historically recognized contributions of nonmonetary assets upon the venture’s initial formation by using the venturers’ respective carrying values (historical cost bases).

The events described below contributed to the development of the fair value measurement approach and the requirements necessary to apply that measurement:

Fair value measurement proliferation in accounting standards — Since the remarks made by Mr. Blowers in 1992, the use of and requirements for fair-value-based measurement significantly increased in U.S. GAAP. For example, FASB Statement 141(R), issued in 2007, generally required acquired assets and liabilities to be recorded at fair value in a business combination. In addition, FASB Statement 160 was issued in 2007 and required entities to measure retained equity interests at fair value when deconsolidating a subsidiary that meets the definition of a business. FASB Statement 157, issued the same year, defined “fair value” and established a framework for measuring it in U.S. GAAP.
Evolution of guidance on when to apply pushdown accounting — The application of pushdown accounting establishes a “new basis.” Specifically, an entity that was acquired by a buyer adjusts its stand-alone financial statements to reflect the buyer’s new basis of accounting by remeasuring its assets and liabilities on the date of acquisition. Since the issuance of the 1979 AICPA Issues Paper on joint venture accounting, some have argued that the establishment of a joint venture should reflect the new basis for businesses contributed.1 While the accounting in the stand-alone financial statements of a business that has been acquired is not the same as that for the formation of a joint venture, some believe that both are instances in which a new basis of accounting should be reflected. Therefore, we believe that there is some background from pushdown accounting that is informative for the evaluation of the basis of accounting for joint ventures.

In 1983, the SEC issued SAB Topic 5.J, which provided an option in certain cases and a requirement in others for the application of fair-value-based measurement for transactions that were not business combinations. However, the SEC’s views evolved, and the Commission expanded the number of situations in which this guidance was required to be applied, including when a group of investors rather than a single investor consummates a transaction. Consequently, in 2001, additional pushdown accounting guidance was provided in EITF Topic D-97 and in comments made by the SEC observer at EITF meetings (all of which was previously included in ASC 805-50-S99-1 through S99-3).

Despite this guidance, in practice, there were many challenges in the determination of when pushdown accounting should be applied. As a result, in 2014, the FASB issued ASU 2014-17, which made it optional for an entity to apply pushdown accounting in its separate financial statements when an acquirer obtains control of it. In response to the issuance of ASU 2014-17, the SEC staff issued SAB 115 to rescind the guidance in SAB Topic 5.J, and the FASB issued ASU 2015-08 to rescind the remaining guidance on pushdown accounting and collaborative groups in ASC 805-50-S99.
SEC remarks in 2009 — At the 2009 AICPA Conference on Current SEC and PCAOB Developments, Joshua Forgione, then associate chief accountant in the OCA, stated:2
Now, as it relates to the accounting for the joint venture itself, Statement 141(R) excludes from its scope the accounting for the formation of a joint venture. The staff has historically conveyed strong views when considering the use of fair value in recording noncash assets contributed to a joint venture. More specifically, many believe that the staff would only support step-up to fair value when certain conditions are met, including where the asset or business is contributed to a new entity and fair value is supported by an equal amount of monetary assets that either remains in the entity or used by the new entity in transactions with parties other than investors in the venture.
There may be questions developing on the topic of new basis for joint venture formation transactions as a result of these recent changes. The good news or, depending on your perspective, the bad news is that I’m not going to roll out a new model for new basis in joint venture formation transactions. There are certainly a number of good questions surrounding new basis accounting in general. In the absence of additional standard setting, there may be more circumstances where it may be appropriate to record the contributed business at fair value. This is an area that requires a significant amount of analysis and you should carefully evaluate the facts and circumstances surrounding the transaction and determine whether you believe new basis of accounting will result in decision-useful information to investors.

Possibly in response to the proliferation of fair-value-based measurement accounting guidance from the FASB, the SEC staff has recently been more receptive to considering the recognition of the initial contributions of businesses received by a joint venture at fair value. Perhaps because of the increasing prevalence of fair value measurement and the issuance of FASB Statement 160 (codified in ASC 810), which requires investors to recognize their retained noncontrolling interest in a business (i.e., contributions of businesses in exchange for a noncontrolling interest) at fair value,3 the SEC staff acknowledged in Mr. Forgione’s 2009 speech that there “may be more circumstances” in which “it may be appropriate” to recognize contributed businesses at fair value. While neither the SEC nor the FASB subsequently issued further guidance as to which circumstances give rise to the application of fair value, we observe that paragraph B55 of the Background Information and Basis for Conclusions in FASB Statement 160 stated, in part, that the derecognition of a subsidiary that is a business is a significant economic event as follows:

Measuring the retained investment to fair value reflects the Board’s view that a decrease in a parent’s ownership interest in a subsidiary to the point that the parent no longer has a controlling financial interest in that subsidiary is a significant economic event. The parent-subsidiary relationship ceases to exist and an investor-investee relationship begins, and that relationship differs significantly from the former parent-subsidiary relationship. Recognizing the retained investment at fair value is more representationally faithful and provides users of financial statements with more relevant information about the value of the retained investment.

8.2.2 Measurement of Initial Contribution of Nonmonetary Assets That Meet the Definition of a Business

We observe that the loss of a controlling financial interest by a parent in a business, as opposed to a new entity’s obtaining a controlling financial interest in that business, requires an investor to measure its retained noncontrolling interest in that business at fair value. Therefore, a venturer contributing a business to a joint venture will record its investment in the joint venture at fair value, and if the joint venture itself records such contributions at their historical cost, there will be a basis difference. Conversely, if the joint venture records its venturers’ contributions at fair value and both venturers contribute a business, it is not likely that there will be a basis difference; if any differences do exist, they will be smaller than they would have been if the joint venture had recorded its venturers’ contributions at their historical cost. Some advocate that this is a reason to record the venturer’s contribution at fair value, so that it is less likely that there will be a basis difference between the venturer’s investments and the venture’s financial statements. Others observe that because the application of pushdown accounting is optional, there should not be a mandate to record the venturer’s contribution at fair value to prevent basis differences.

What is clear is that until a joint venture adopts ASU 2023-05, there is no prescriptive framework in U.S. GAAP regarding the recognition and measurement in the joint venture’s financial statements for net assets received from its venturers. Furthermore, we understand that under current GAAP, there is diversity in the preference for the measurement approach used in a joint venture’s financial statements.

In summary, we believe that it remains acceptable for a joint venture to recognize a business or businesses contributed to it at the venturers’ historical bases until the joint venture adopts ASU 2023-05, at which point fair value recognition would be required. If an entity determines that fair value recognition and measurement for the joint venture is appropriate, we believe that the entity should early adopt the amendments in the ASU and consider the guidance discussed in Chapter 9.

Footnotes

Paragraph 53(a) of the 1979 AICPA Issues Paper, “Joint Venture Accounting.”

The full text of Mr. Forgione’s speech is available on the SEC’s Web site.

Under ASU 2017-05, contributions that are conveyances of oil and gas mineral rights or transfers of goods or services in a contract with a customer that are within the scope of ASC 606 are not within the scope of ASC 810.

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This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.