FASB proposes accounting for joint ventures

Michael A. Antonetti, Jenny Hall, Stephanie Lehmann

A FASB proposal provides guidance on accounting for joint venture formations. The board is seeking comments.

In under a minute

On Oct. 27, 2022, the Financial Accounting Standards Board (FASB) issued a proposed Accounting Standards Update (ASU), “Business Combinations – Joint Venture Formations (Subtopic 805-60): Recognition and Initial Measurement,” which would provide guidance for recognition and measurement of contributions made to a joint venture at its formation, in the joint venture’s separate financial statements.
Currently, GAAP does not provide specific guidance on how a joint venture should recognize and measure assets contributed and liabilities assumed at its formation. The proposed guidance would require that at the formation date, a joint venture would apply a new basis in accounting by valuing the net assets contributed upon formation. The value of the net assets in total is then allocated to individual assets and liabilities by applying Topic 805 with certain exceptions.
The proposed ASU provides that a joint venture formation date is the date when an entity initially meets the definition of a joint venture.
The amendments in this proposed ASU do 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 proposed changes to the joint venture formation guidance would apply prospectively. In addition, joint ventures formed prior to the effective date of the proposed ASU would have an option to elect to apply the guidance retrospectively.
Comments on the proposal are due by Dec. 27, 2022.

Breaking it down

The Accounting Standards Codification (ASC) Master Glossary defines a joint venture:

An entity owned and operated by a small group of businesses (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 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 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 joint venture. The ownership of a joint venture seldom changes, and its equity interests usually are not traded publicly. A minority public ownership, however, does not preclude an entity from being a joint venture. As distinguished from a corporate joint venture, a joint venture is not limited to corporate entities.

Sharing joint control between members is necessary to meet the accounting definition of a joint venture. In addition, according to ASC 845-10-S99-2, the Securities and Exchange Commission (SEC) staff “would object to a conclusion that joint control is the only defining characteristic of a joint venture.”

Crowe observation: We don’t use the term joint venture lightly, as we believe the accounting definition requires a comprehensive qualitative assessment. The GAAP definition of a joint venture contains the words “frequently,” “may,” “seldom,” and “usually,” indicating limited exceptions, and GAAP does not provide specific guidance on how a joint venture should recognize and initially measure assets contributed and liabilities assumed at its formation. Furthermore, the evaluation of whether an entity is a joint venture requires consideration of whether the entity should be consolidated by any of its venturers using the variable interest model.

In order to reduce diversity in practice, on Oct. 27, 2022, the FASB issued a proposed ASU, “Business Combinations – Joint Venture Formations (Subtopic 805-60): Recognition and Initial Measurement,” that would provide guidance for recognition and initial measurement of contributions made to a joint venture at its formation in the joint venture’s separate financial statements. While the proposal does not amend the joint venture definition in Topic 323, it does provide clarity on the initial formation accounting.

Key highlights of the proposed ASU

The newly formed joint venture is considered a new reporting entity without an acquirer. There is no accounting acquirer to identify since there is shared joint control between both parties. The newly formed joint venture would apply a new basis of accounting in accordance with the business combinations guidance.

Crowe observation: Measuring a new basis of accounting in accordance with the business combination guidance is a significant change from previous guidance or lack thereof. In practice we have seen assets and businesses contributed to the joint venture recognized at fair value or at venturers’ carrying amounts. The new ASU would eliminate diversity and provide consistency in the accounting.

The proposed ASU defines the formation date as the date in which the entity meets the definition of a joint venture.

Crowe observation: The proposed ASU does not change or clarify the existing definition of a joint venture; therefore, we would not anticipate any change in the volume of joint ventures formed that truly meet the accounting definition of a joint venture. Practitioners should continue to perform a comprehensive qualitative assessment when determining if an entity meets the joint venture definition.

The proposed ASU does not allow for measurement period adjustments. In business combinations the measurement period is the period during which specific provisional items are resolved; it cannot be greater than a year and ends as soon as the provisional items are resolved.

Crowe observation: In practice we typically see venturers agree on the relative value of contributions to the joint venture, but they might not do a fair value assessment under ASC 820, including assessing the fair value of individual long-term tangible and intangible assets. In the absence of a measurement period, venturers will need to be proactive in completing a fair value assessment of the joint venture, including determining fair value of the individual net assets, especially if the joint venture is formed near the end of the reporting period.

The initial measurement of the joint venture’s total net assets equals 100% of the fair value of the joint venture’s outstanding equity at the formation date.

Crowe observation: Given the new basis of accounting is the fair value of the joint venture as a whole, goodwill would be recorded for any amount in excess of the fair value assigned to the joint venture’s net assets. The context of the proposed ASU does not distinguish between a transaction that meets the GAAP definition of a business and one that does not (an asset transaction), as the FASB staff believed that most transactions would involve businesses.

Transition and effective date

Currently, the proposed ASU has no effective date. The board will consider comments received on the proposed ASU before determining an effective date and clarifying if early adoption will be permitted. It is intended that joint ventures formed after the effective date will apply the guidance prospectively and joint ventures formed prior to the effective date will have the option to apply the proposed guidance retrospectively.

Crowe observation: If a joint venture with a formation date that occurs before the effective date applies the ASU retrospectively, careful consideration should be made when determining fair value at the formation date. The fair value should be as of the formation date based on facts and circumstances that existed at the formation date.

Comments on the proposal are due by Dec. 27, 2022.

FASB SEC ASC 805