Chapter 8 — Accounting by the Joint Venture
Chapter 8 — Accounting by the Joint Venture Before Adopting ASU 2023-05
8.1 Overview
This chapter discusses the accounting by a joint venture for
nonmonetary contributions upon formation before the adoption of ASU 2023-05. Therefore, the Codification
references included in this chapter do not show the pending content (transition
guidance in ASC 805-60-65-01) related to the ASU. For information on the accounting
by a joint venture after the adoption of ASU 2023-05, see Chapter 9.
ASC 805-10
15-4 The guidance in the
Business Combinations Topic does not apply to any of the following:
a. The formation of a joint venture . . . .
ASC 845-10
15-4 The
guidance in the Nonmonetary Transactions Topic does not
apply to the following transactions: . . .
b. A transfer of nonmonetary assets solely between
entities or persons under common control, such as
between a parent and its subsidiaries or between two
subsidiaries of the same parent, or between a
corporate joint venture and its owners . . . .
Before the issuance of ASU 2023-05,U.S. GAAP did not address the accounting by legal entities that meet the definition of a joint venture for noncash assets contributed by venturers upon the initial joint venture formation. The EITF evaluated the accounting by joint ventures for businesses received at formation but did not reach a consensus on this issue (Issue 98-4). In addition, ASC 805 and ASC
845 have expressly excluded from their scope the formation of a joint venture and
transfers between joint ventures and their owners, respectively.
In the absence of prescriptive FASB guidance, some joint ventures recognized
contributions of nonmonetary assets upon the venture’s initial formation by using
the venturers’ carrying values (historical cost bases), while other joint ventures
have recognized such contributions at their fair values. To eliminate this diversity
in practice, the FASB included a project on its technical agenda to address the
accounting by a joint venture for the initial contribution of nonmonetary and
monetary assets to the venture. This project culminated in the August 2023 issuance
of ASU 2023-05, which is effective for all joint venture formations with a formation
date on or after January 1, 2025. Early adoption is permitted.
This chapter focuses on the accounting for joint ventures before the adoption of
ASU 2023-05. Until such adoption, practitioners may continue to apply the guidance
discussed in Section
8.2 (specifically, by using venturers’ carrying values [historical
cost bases] in nonmonetary assets that meet the definition of businesses) and in
Section 8.3 on the
accounting by a joint venture for the initial contribution of nonmonetary assets to
the joint venture (specifically, by using venturers’ carrying values [historical
cost bases] in nonmonetary assets that do not meet the definition of a business). A
new Chapter 9 has been
added to this publication to reflect the amendments in ASU 2023-05 for those that
want to apply a fair value measurement model to a joint venture formation and thus
apply 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:
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Contribution of the asset or business was to a new entity.
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The fair value was objectively determinable and supported by equal contributions of monetary assets by the other investor(s).
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The monetary assets must have stayed in the new venture or been used for transactions with parties other than the venturers.
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There was an equal allocation of equity and profits or losses between the venturers.
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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:
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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.
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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.
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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:2Now, 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
1
Paragraph 53(a) of the 1979 AICPA Issues
Paper, “Joint Venture Accounting.”
3
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.
8.3 Measurement of Initial Contribution of Nonmonetary Assets That Do Not Meet the Definition of a Business
ASC 323-10
30-2 Except as provided in the following sentence, an investor shall measure an investment in the common stock of an investee (including a joint venture) initially at cost in accordance with the guidance in Section 805-50-30. An investor shall initially measure, at fair value, the following:
- A retained investment in the common stock of an investee (including a joint venture) in a deconsolidation transaction in accordance with paragraphs 810-10-40-3A through 40-5
- An investment in the common stock of an investee (including a joint venture) recognized upon the derecognition of a distinct nonfinancial asset or distinct in substance nonfinancial asset in accordance with Subtopic 610-20.
ASC 845-10 — SEC Materials — SEC Staff Guidance
SAB Topic 5.G, Transfers of Nonmonetary Assets by Promoters or Shareholders
S99-1 The following is the text
of SAB Topic 5.G, Transfers of Nonmonetary Assets by
Promoters or Shareholders.
Facts: Nonmonetary
assets are exchanged by promoters or shareholders for all or
part of a company’s common stock just prior to or
contemporaneously with a first-time public offering.
Question: Since FASB
ASC paragraph 845-10-15-4 (Nonmonetary Transactions Topic)
states that the guidance in this Topic is not applicable to
transactions involving the acquisition of nonmonetary assets
or services on issuance of the capital stock of an
enterprise, what value should be ascribed to the acquired
assets by the company?
Interpretive Response:
The staff believes that transfers of nonmonetary assets to a
company by its promoters or shareholders in exchange for
stock prior to or at the time of the company’s initial
public offering normally should be recorded at the
transferors’ historical cost basis determined under
GAAP.
The staff will not
always require that predecessor cost be used to value
nonmonetary assets received from an enterprise’s promoters
or shareholders. However, deviations from this policy have
been rare applying generally to situations where the fair
value of either the stock issuedFN1 or assets
acquired is objectively measurable and the transferor’s
stock ownership following the transaction was not so
significant that the transferor had retained a substantial
indirect interest in the assets as a result of stock
ownership in the company.
__________________________________
FN1 Estimating the fair
value of the common stock issued, however, is not
appropriate when the stock is closely held and/or seldom or
ever traded.
ASC 810-10
40-5 If a parent deconsolidates a subsidiary or derecognizes a group of assets through a nonreciprocal transfer
to owners, such as a spinoff, the accounting guidance in Subtopic 845-10 applies. Otherwise, a parent shall
account for the deconsolidation of a subsidiary or derecognition of a group of assets specified in paragraph
810-10-40-3A by recognizing a gain or loss in net income attributable to the parent, measured as the difference
between:
- The aggregate of all of the following:
- The fair value of any consideration received
- The fair value of any retained noncontrolling investment in the former subsidiary or group of assets at the date the subsidiary is deconsolidated or the group of assets is derecognized
- The carrying amount of any noncontrolling interest in the former subsidiary (including any accumulated other comprehensive income attributable to the noncontrolling interest) at the date the subsidiary is deconsolidated.
- The carrying amount of the former subsidiary’s assets and liabilities or the carrying amount of the group of assets.
ASC 970-323
Contribution of Real Estate
30-3 An investor that contributes real estate to the capital of a real estate venture generally should record its investment in the venture at fair value when the real estate is derecognized, regardless of whether the other investors contribute cash, property, or services. The transaction shall be accounted for in accordance with the guidance in paragraphs 360-10-40-3A through 40-3C. Some transactions are sales of an ownership interest that result in an entity being an investor in a real estate venture. An example of such a transaction includes one in which investor A contributes real estate with a fair value of $2,000 to a venture and investor B contributes cash in the amount of $1,000. The real estate is not considered a business or nonprofit activity and, therefore, is within the scope of Subtopic 610-20 on gains and losses from the derecognition of nonfinancial assets. Investor A immediately withdraws the cash contributed by investor B and, following such contributions and withdrawals, each investor has a 50 percent interest in the venture (the only asset of which is the real estate). Assuming investor A does not have a controlling financial interest in the venture, investor A applies the guidance in paragraphs 610-20-25-5 and 610-20-25-7. When investor A meets the criteria to derecognize the property, investor A measures its retained ownership interest at fair value consistent with the guidance in paragraph 610-20-32-4 and includes that amount in the consideration used in calculating the gain or loss on derecognition of the property.
There is no currently prescribed guidance under U.S. GAAP on the accounting by
the joint venture when receiving contributions of assets that do not meet the
definition of a business. While the SEC staff has indicated that there may be more
circumstances in which the recording of the contribution of a business at fair value
is appropriate, the staff has not provided recent remarks or guidance for
contributions of assets that do not meet the definition of a business. Therefore,
the above codified guidance written for the venturer’s accounting is frequently
referenced by analogy to support the accounting by the joint venture itself. In the
absence of guidance from the FASB or SEC, these various analogies have been used to
justify the recognition and measurement methods shown in the table below for
contributions received by the joint venture. The table below is followed by a
detailed explanation of each method.
Basis of Presentation | Applicability |
|---|---|
Historical cost | Acceptable for joint ventures formed before January 1, 2025. |
Fair value (full step-up) | If a venture would like to apply fair value measurement, the entity should early
adopt ASU 2023-05. |
Partial step-up | As a result of ASU 2017-05, we believe that partial step-up would be
prohibited. |
- Historical cost — Proponents of historical cost measurement believe that joint ventures should record contributions of nonmonetary assets that do not meet the definition of a business at historical cost. They observe that in the formation of the joint venture, the venturers who contributed the nonmonetary assets control (albeit jointly) the joint venture. Because the venturer has joint control over the joint venture and thus has not completely surrendered control over the contributed asset(s), a new basis of measurement is not appropriate.Proponents of this view also look to the guidance in ASC 805-50 on common-control transactions. Although joint venture formation is not technically within the scope of the guidance on common-control transactions since the venturers, by definition, jointly control the joint venture, proponents of this view believe that joint venture formation transactions are similar to common-control transactions. Specifically, proponents of this view believe that under the guidance in ASC 805-50, because there is no change in control, there is no change in the basis of the net assets. ASC 805-50 prescribes that in a common-control transaction, the net assets are recorded by the receiving entity at the carrying amounts of the entity that is transferring the net assets. Proponents of this view believe that the accounting for the joint venture should mirror the guidance in ASC 805-50.Some proponents of historical cost measurement have also analogized to SAB Topic 5.G (codified in ASC 845-10-S99-1) in analyzing joint venture formation transactions. That guidance states that the nonmonetary assets are normally recorded at a historical cost basis (i.e., carrying amounts).
- Fair value (full step-up) — Proponents of fair value (full step-up) measurement believe that nonmonetary assets received from venturers that do not meet the definition of a business should be recorded at fair value by the joint venture. They believe that the initial measurement of nonmonetary assets received by the joint venture upon its formation should be treated no differently than any initial measurement of nonmonetary assets by an entity when received from a third party in a reciprocal exchange.As discussed in Section 8.2.2, in accordance with ASC 810-10-40-5, retained interests in a business that is deconsolidated are initially measured at fair value. In part to align the accounting for the measurement upon derecognition of assets and businesses, the FASB issued ASU 2017-05, which also requires retained interests in a previously consolidated subsidiary that does not meet the definition of a business to be initially measured at fair value. Even though the guidance is for investors, proponents of the view that joint ventures should record contributions of nonmonetary assets that do not meet the definition of a business at fair value analogize to the guidance in ASC 323-10-30-2(b). In accordance with the proponents of fair value accounting for businesses contributed to a joint venture, they advocate that this is a reason to record the venturers’ contribution at fair value, so that there is no basis difference between the venturers’ investments and the joint venture’s financial statements.After the issuance of ASU 2023-05, fair value (full step-up) will be the required basis of presentation. See Chapter 9 for a discussion of the FASB’s basis for conclusions regarding this approach.
- Partial step-up — Some believe that the substance of some transactions in which monetary assets are withdrawn may be a partial sale of nonmonetary assets that do not meet the definition of a business and therefore that the joint venture should partially step up the contributed assets. As a result of ASU 2017-05, we believe that this approach is prohibited.
8.3.1 Summary of Views on Measurement of Initial Contribution of Nonmonetary Assets That Do Not Meet the Definition of a Business
We believe that before the adoption of ASU
2023-05, it remains acceptable for a joint venture to
recognize nonmonetary assets contributed to it at the venturer’s historical cost
basis when the nonmonetary assets do not meet the definition of a business. As
observed above, there are some who believe that fair value recognition is also
acceptable. If an entity determines that fair value recognition is appropriate,
we believe that the entity should early adopt the ASU.
8.4 Other Matters
8.4.1 Contribution of Nonmonetary Assets After Formation
Nonmonetary assets or businesses contributed to a joint venture in a separate and distinct transaction after the joint venture’s formation date are generally recorded at fair value. However, if the post-formation contribution is, in substance, an extension of the original formation of the joint venture, it may be appropriate to record it at historical cost when the initial formation transaction was accounted for at historical cost.
The existence of one or more of the following criteria may indicate that the subsequent contribution is an extension of the joint venture’s original formation and that it thus may be appropriate to record the subsequent contribution at historical cost (but only if the initial contribution was recorded at historical cost):
- The subsequent contribution is required under the original terms of the joint venture agreement.
- The venturers consider the subsequent contribution to be part of the original formation of the joint venture.
- The activities of the original joint venture (before the post-formation contribution) are considered insignificant or inconsequential.
- The time from the original formation to the post-formation contribution is relatively short.
The preceding list is not intended to be all-inclusive, and entities should carefully consider their facts and circumstances.
Example 8-1
On January 1, 20X7, two venturers form a limited liability partnership (LLP) by contributing $100 each. As of the formation date, the LLP is considered a joint venture in accordance with ASC 323. During the first year, the joint venture’s only transaction is to enter into an office space lease, an activity considered insignificant to the LLP’s planned business activities. On January 1, 20X8 (the contribution date), each venturer contributes an existing business to the joint venture. The estimated fair value of each of the contributed businesses is $100 million.
While the legal formation date of the joint venture was January 1, 20X7, the venturers used the LLP to facilitate the formation of a new joint venture one year later. In other words, the contribution date is, in substance, the formation date. As a result, the venturers should treat the contribution date as if it were the formation date and evaluate whether their contributions should be recognized at the venturers’ historical costs or at fair value (see Section 8.2.2) as of January 1, 20X8.
Example 8-2
Venturer X and Venturer Y each contribute a fully occupied commercial building to a newly formed entity that
meets the definition of a joint venture in accordance with ASC 323. Voting rights, as well as profits and losses,
are shared equally between X and Y. Several years later, Venturer Z, an unrelated party, contributes another
commercial building to the joint venture. When Z makes its contribution, the joint venture is restructured
so that X, Y, and Z share equally in profits and losses. All decisions regarding the joint venture require the
unanimous consent of all three owners. Venturer Z’s admission was not contemplated at the joint venture’s
formation. Therefore, the joint venture should account for the building contributed by Z at fair value.
8.4.2 Differences in Accounting Policies
Upon formation of a joint venture, the venture selects accounting policies. Although a joint venture has
the option of conforming its accounting policies to those of the venturers, it is not required to do so.
Should the joint venture select accounting policies that are different than those of the venturers, it is not
a change in accounting principle under ASC 250. See Section 5.1.3 for further discussion of differences
in accounting policies between equity method investees and investors.
8.4.3 Joint Venture’s Investment in the Stock of a Venturer
A joint venture may purchase the stock of one of its venturers for various reasons, including to
(1) provide share-based compensation to the joint venture’s employees, (2) hedge the cost and cash
requirements of stock appreciation rights, or (3) hold the stock as an investment.
We believe that the joint venture should follow the tentative conclusion reached by the EITF in Issue 98-2, which states:
[A]ssuming the joint venture partner has substantive operations apart from its investment in the joint venture, a joint venture should account for an investment in the stock of its joint venture partner as an asset in its separate financial statements. That asset should be accounted for using the equity method of accounting, with an elimination of the reciprocal ownership investments.
While no final consensus was reached by the EITF, we support its tentative conclusion in Issue 98-2 and believe that it should be applied by all joint ventures.
8.4.4 Start-Up Costs Incurred by the Joint Venture
ASC 720-15 — Glossary
Start-Up Activities
Defined broadly as those one-time activities related to any of the following:
- Opening a new facility
- Introducing a new product or service
- Conducting business in a new territory
- Conducting business with an entirely new class of customers (for example, a manufacturer who does all of its business with retailers attempts to sell merchandise directly to the public) or beneficiary
- Initiating a new process in an existing facility
- Commencing some new operation.
ASC 720-15
25-1 Costs of start-up activities, including organization costs, shall be expensed as incurred.
A joint venture may incur certain costs associated with start-up activities. The definition of “start-up activities” in ASC 720-15-20 is broad and may include the start-up activities of a joint venture. Because the purpose of a corporate joint venture in accordance with ASC 323-10-20 includes the development of a new market, product, technology, or production or other facilities (as discussed in Section 7.2), costs associated with these start-up activities should be expensed as incurred under ASC 720-15-25-1.