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- ASU 2023-05 provides guidance on how a joint venture initially recognizes and measures contributions received at its formation date.
- The ASU requires a joint venture to apply a new basis of accounting at its formation date by valuing the net assets contributed at fair value for both business and asset transactions. The value of the net assets in total is then allocated to individual assets and liabilities by applying Topic 805 with certain exceptions.
- The formation date of a joint venture is defined as the date when an entity initially meets the definition of a joint venture, which is not necessarily the date the legal entity was formed. All facts and circumstances, including assessing multiple arrangements, need to be considered when determining the formation date.
- Differing from the proposed ASU, the final ASU allows a joint venture to apply measurement period guidance in accordance with Subtopic 805-10, allowing the amounts recognized upon formation to be adjusted for provisional items during the measurement period not to exceed one year from the formation date.
- The ASU does not amend the definition of a joint venture, the existing guidance for the accounting by an equity method investor for its investment in a joint venture, or the accounting by a joint venture for contributions received subsequent to formation.
- The ASU, which is effective for joint ventures with a formation date on or after Jan. 1, 2025, is required to be applied prospectively. Additionally, joint ventures with a formation date prior to Jan. 1, 2025, have an option to elect to apply the guidance retrospectively, provided adequate information is available. Excluded from the scope of the ASU are all entities that may be proportionately consolidated by one or more of the venturers, not-for-profit entities, and collaborative arrangements within the scope of Topic 808 (except for any part of a collaborative arrangement that is conducted in a separate legal entity that meets the definition of a joint venture).
New basis of accounting – now what?
Previously, GAAP did not provide specific guidance on how a joint venture should initially recognize and measure the assets received and liabilities assumed at its formation in its separate financial statements. This lack of authoritative guidance resulted in diversity in practice, with some joint ventures recognizing and initially measuring contributions received at the carrying amounts of the venturer who contributed those net assets, and others recognizing and initially measuring at fair value.
ASU 2023-05 requires that at its formation date, a joint venture must apply a new basis of accounting by valuing the net assets contributed by its venturers at fair value. The initial measurement of the joint venture’s total net assets equals 100% of the fair value of the joint venture’s outstanding equity immediately following formation. The fair value of the net assets as a whole is then allocated to the individual assets and liabilities by applying the guidance in Topic 805, with certain exceptions, and any excess is recognized as goodwill, regardless of whether the net assets contributed constitute a business. Any negative goodwill resulting from the formation transaction is recognized as an adjustment to equity.
Crowe observation: Given the new basis of accounting is the fair value of the joint venture as a whole, goodwill will be recorded for any amount in excess of the fair value assigned to the joint venture’s identifiable net assets. The ASU does not distinguish between a contribution of net assets that meets the GAAP definition of a business and one that does not (an asset transaction), as the FASB staff believes that most transactions would involve businesses.
The ASU allows for measurement period adjustments, wherein the amounts recognized upon formation can be adjusted for provisional items during the measurement period, not to exceed one year from the formation date.
Crowe observation: In practice, venturers typically agree on the relative value of contributions to the joint venture, but they might not have completed a fair value assessment under ASC 820, including assessing the fair value of individual long-term tangible and intangible assets. Venturers now will have up to one year to obtain the relevant financial information and adjust provisional items.
The ASU requires certain disclosures to aid the user of the financial statements in understanding the implications of the joint venture formation. The required disclosures include the formation date, a description of the purpose of the joint venture formation, the fair value of the joint venture as a whole on the formation date, amounts recognized for each major class of assets and liabilities, and a description of the elements constituting goodwill.
Crowe observation: We anticipate that the required disclosures surrounding the joint venture formations will enhance financial reporting and allow investors to clearly understand the financial impacts of the joint venture on the financial statements.
Transition and effective date
ASU 2023-05 is effective for joint venture formations with a formation date on or after Jan. 1, 2025. Early adoption is permitted. Entities may elect to apply the guidance retrospectively to joint ventures with a formation date prior to Jan. 1, 2025.
Crowe observation: If a joint venture has a formation date that is prior to Jan. 1, 2025, careful consideration should be given when electing to retroactively apply ASU 2023-05. Fair value must be measured as of the formation date based only on facts and circumstances that existed at that date.
