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6.2 Identifying a joint venture
Publication date: 30 Sep 2023
us Equity method of accounting guide
In practice, the term “joint venture” is usually referred to rather loosely. Structures or transactions that are not joint ventures for accounting purposes are commonly called joint ventures.
A corporate joint venture is defined as follows.
Definition from ASC 323-10-20
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.
This definition does not include investments in unincorporated joint ventures (including partnerships), although ASC 323-30 concludes that many of the provisions of ASC 323 are also appropriate in assessing investments in unincorporated joint ventures. Therefore, in practice, a joint venture is not restricted by the type or legal form of the entity. Joint venture accounting does not apply to arrangements between entities under common control.
At the formation of a new entity (or when an investor becomes involved with or acquires an interest in an existing entity), an investor in the entity is required to first determine if the entity is a variable interest entity (see CG 2). If the entity is a VIE and is required to be consolidated by one of the investors, it would not meet the definition of a joint venture. The VIE model provides a scope exception from the application of that model to an entity if the entity is a business and certain conditions are met, which is discussed in EM 6.2.1. On the other hand, if the entity is a VIE, but no party is required to consolidate it (including after giving effect to any related party considerations), the entity may meet the definition of a joint venture. An entity that is a VIE and meets the definition of a joint venture would be considered an entity over which power is shared among its equity investors, with no investor consolidating the joint venture. If the entity is not a VIE, then the investor should assess if it is required to consolidate the entity under the voting interest (VOE) model (see CG 7.1). If the investor is not required to consolidate the entity under either the VIE model or the VOE model, the investor would determine if the entity meets the definition of a joint venture, which is discussed further in EM 6.2.2 and EM 6.2.3.
6.2.1 Applying the business scope exception to joint ventures
ASC 810-10 provides for a scope exception from the application of the VIE model to an entity if the entity is a business and certain conditions are met. The scope exception is primarily an investor exception (versus an entity exception). Thus, each investor in the entity will have to assess whether it qualifies for the scope exception. One investor in the entity may qualify while another investor may not. The application of the scope exception necessitates judgment. Due to the characteristics of many joint ventures, qualification for the scope exception is expected to be infrequent, so investors will generally have to assess the entity under the VIE guidance.
An investor in an entity that initially meets the requirements for the scope exception should continually reassess that it qualifies for it. If an investor in an entity no longer meets the requirements for the scope exception, the VIE model would be applied prospectively.
There is no investor scope exception from the application of the VIE guidance to an entity if the entity is not a business.
Excerpt from ASC 810-10-15-17(d)
A legal entity that is deemed to be a business need not be evaluated by a reporting entity to determine if the legal entity is a VIE under the requirements of the Variable Interest Entities Subsections unless any of the following conditions exist (however, for legal entities that are excluded by this provision, other GAAP should be applied):
- The reporting entity, its related parties, or both participated significantly in the design or redesign of the legal entity. However, this condition does not apply if the legal entity is an operating joint venture under joint control of the reporting entity and one or more independent parties or a franchisee.
- The legal entity is designed so that substantially all of its activities either involve or are conducted on behalf of the reporting entity and its related parties.
- The reporting entity and its related parties provide more than half of the total of the equity, subordinated debt, and other forms of subordinated financial support to the legal entity based on an analysis of the fair values of the interests in the legal entity.
- The activities of the legal entity are primarily related to securitizations or other forms of asset-backed financings or single-lessee leasing arrangements.
While the presence of any of the conditions in ASC 810-10-15-17(d) would disqualify an investor from applying the scope exception, conditions ASC 810-10-15-17(d)(2) and ASC 810-10-15-17(d)(3) are most commonly the provisions that prevent an investor from applying the business scope exception to a joint venture.
ASC 810-10-15-17(d)(2): Substantially all
An understanding of the purpose and design of the entity is required in order to evaluate whether substantially all of its activities either involve or are conducted on behalf of the reporting entity and its related parties. Generally, investors form a joint venture for a specific purpose that will benefit all of the investors, as opposed to for the benefit of just one investor. However, some joint ventures have only two (or a few) investors, in which case it is not unusual for the substantially all of the activities to be on behalf of one of the investors. The assessment of the substantially all criteria is primarily qualitative, and the phrase “substantially all” does not indicate a quantitative guideline. See CG 2.3.4 for additional guidance.
ASC 810-10-15-17(d)(3): Subordinated financial support
Most variable interests in an entity are considered subordinated financial support. As a result, this scope exception would generally be available only when it is obvious that the investor would not absorb the majority of the economics of the entity on a fair value basis. For many 50:50 joint venture arrangements, it will be difficult to make this assertion. In a 50:50 joint venture, while the economics are intended to be shared evenly, this may not be the case. There are often commercial arrangements between the investors and the joint venture that may be variable interests and it becomes difficult to establish that the economics with respect to all the variable interests held by the investors are shared equally. This means it is likely the entity will need to be evaluated under the VIE model. See CG 2.3.4 for additional guidance.
Example EM 6-1 and Example EM 6-2 illustrate the application of the business scope exception guidance in ASC 810-10-15-17(d)(2) and ASC 810-10-15-17(d)(3).
EXAMPLE EM 6-1
Determining whether an investor in an entity can apply the business scope exception in ASC 810-10-15-17(d)
Determining whether an investor in an entity can apply the business scope exception in ASC 810-10-15-17(d)
Company A and Company B form a new entity, Newco. Company A contributes one of its subsidiaries, a business with a fair value of $100 million, in exchange for 50% of the equity of Newco. Company B contributes $100 million cash in exchange for 50% of the equity of Newco. The cash contributed by Company B will remain in Newco for operating expenses to develop new products and markets. Newco, which is deemed to be a business, was created so that all of its activities are conducted on behalf of Company A. Newco sells all of its output to Company A and all of Newco’s employees are seconded from Company A. Newco obtains a $120 million, six year, fixed 5% interest rate loan from a bank, which is guaranteed by Company A and Company B.
Company A and Company B each have two of the four board seats of Newco and unanimous approval from all board members is required for all decisions related to Newco.
Does Company A qualify for the business scope exception in ASC 810-10-15-17(d)?
Analysis
No. Newco is deemed to be a business. However, given that Newco sells all of its output to Company A and Company A provides all of the employees of Newco, all of the activities of Newco are deemed to be conducted on behalf of Company A. Therefore, the business scope exception is not available to Company A as the condition in ASC 810-10-15-17(d)(2) which precludes use of the exception exists. Company A would need to evaluate its investment in Newco under the VIE model. See CG 2.3 for additional guidance.
EXAMPLE EM 6-2
Determining whether an investor in an entity can apply the business scope exception in ASC 810-10-15-17(d)
Determining whether an investor in an entity can apply the business scope exception in ASC 810-10-15-17(d)
Company A and Company B form a new entity, Newco, for the purpose of developing new products and accessing new markets. Company A contributes cash in exchange for 50% of the equity of Newco, and Company B contributes a division of its operations (that constitutes a business) in exchange for 50% of the equity of Newco. Company B also provides a loan to Newco to fund its working capital requirements.
Company A and Company B each have two of the four board seats of Newco and unanimous approval from all board members is required for all decisions related to Newco.
Does Company B qualify for the business scope exception in ASC 810-10-15-17(d)?
Analysis
No. Newco is deemed to be a business. However, Company B is providing more than half of the total subordinated financial support to Newco through its 50% equity interest and the working capital loan to Newco. Therefore, the business scope exception is not available to Company B as the condition in ASC 810-10-15-17(d)(3) that precludes use of the exception exists. Company B would need to evaluate its investment in Newco under the VIE model. See CG 4.1 for additional guidance.
6.2.2 Joint control
The most distinctive characteristic of a joint venture is the concept of joint control. An AcSEC Issue Paper, which is not authoritative guidance, describes the concept of joint control in its definition of a joint venture. This definition and the concept of joint control are widely applied in practice.
Definition from AcSEC Issue Paper, Joint Venture Accounting (7/17/79), Paragraph 51(b)
Joint venture: 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.
The AcSEC definition establishes joint control over the decision-making process as the most significant attribute of joint ventures, regardless of the form of legal ownership or voting interest held. That is, the type of legal entity (e.g., corporation, partnership) is not relevant as long as the entity’s governing documents provide for each venturer to exercise joint control. There is a distinction between “joint control over decision making” and a structure in which no single party has “control” over decision making. The latter does not meet the definition of a joint venture as all investors need not agree in order to approve an entity’s action.
Joint control exists when the investors are able to participate in all of the significant decisions of an entity. An understanding of the governance structure of the entity is necessary to determine whether there is joint control over the significant decisions of the venture by all venturers. At times, power over the significant decisions of the entity may rest with the board of directors; however, the rights of all venturers should be considered in making the assessment as to whether joint control exists. The venturers, therefore, at a minimum, must be able to effectively participate in those significant decisions through substantive veto or approval rights. To be substantive, these rights must have no significant barriers to exercise (i.e., significant penalties or other hurdles making it difficult or unlikely they could be exercised).
Joint control can still exist when public shareholders own interests in a joint venture. The definition of a joint venture indicates that, while stock of a joint venture is usually not traded publicly, a noncontrolling interest held by public ownership does not preclude a corporation from being a corporate joint venture. In the unusual instance when the public has an equity interest in a joint venture, that interest is usually small relative to the other venturers’ interests and does not provide the public shareholders with a means to actively participate in all significant decision-making of the joint venture. In such cases, joint control can still exist if control rests jointly with the venturers excluding the public shareholders.
Given that joint control requires unanimous consent over all significant decisions by all the venturers, it is not uncommon for venturers to disagree on certain significant decisions. In these cases, it is important to understand how disagreements are resolved. Sometimes, when the venturers cannot agree, no action is approved and no further action on that issue is taken by the venturers or venture. Other times, the dispute may go to arbitration for resolution. Settlement of disputes through arbitration does not preclude the investors from having joint control; however, if one investor has tie-breaking authority in the event of a dispute, joint control does not exist.
Some investors may also have unilateral control over decisions that are not significant to the joint venture’s operations (e.g., selecting the auditor of the joint venture). Because these decisions are considered protective rather than participating, joint control over these decisions is not required. In these cases, the venturers would still be deemed to have joint control over the significant decisions.
Question EM 6-1, Question EM 6-2, and Question EM 6-3 discuss joint ventures that have more than two venturers. Question EM 6-4 addresses whether all venturers are required to have an equal ownership interest in the joint venture.
Question EM 6-1
Can a joint venture have more than two venturers?
Can a joint venture have more than two venturers?
PwC response
Yes, provided the joint venture satisfies all of the requirements in the definition of a joint venture, including the requirement for joint control by all venturers. Thus, each venturer in the joint venture would need to participate in the joint control over the joint venture.
Question EM 6-2
Assume three investors create a new entity, with each investor owning one-third of the equity of the new entity, and each having one-third of the investor votes. Investor approval over significant decisions of the new entity requires a simple majority of the investor votes. Does this qualify as joint control?
Assume three investors create a new entity, with each investor owning one-third of the equity of the new entity, and each having one-third of the investor votes. Investor approval over significant decisions of the new entity requires a simple majority of the investor votes. Does this qualify as joint control?
PwC response
No, although no investor controls the entity, a majority vote in this case means that only two of the three investors are needed to make the significant decisions of the new entity. This does not meet the concept of joint control. However, joint control would exist if investor approval over significant decisions required a unanimous decision by all three investors.
Question EM 6-3
Assume three investors create a new entity, with each investor owning one-third of the equity and significant decisions require unanimous approval of all three investors. If the investors cannot agree on a decision within 30 days after the initial disagreement, an independent arbitrator will be engaged to resolve the issue within 25 business days once engaged. Does this qualify as joint control?
Assume three investors create a new entity, with each investor owning one-third of the equity and significant decisions require unanimous approval of all three investors. If the investors cannot agree on a decision within 30 days after the initial disagreement, an independent arbitrator will be engaged to resolve the issue within 25 business days once engaged. Does this qualify as joint control?
PwC response
Yes, joint control exists as investor approval over significant decisions requires a unanimous vote of all investors. The use of an arbitrator to aid in the resolution of a potential disagreement does not negate the joint control terms as stipulated in the joint venture agreement. The arbitrator is only engaged and used when there is a disagreement among the three investors and generally would not be making the significant decisions on an ongoing basis.
Question EM 6-4
Are all venturers required to have an equal ownership interest in the joint venture (e.g., are two venturers in a joint venture required to each have a 50% ownership interest in the joint venture)?
Are all venturers required to have an equal ownership interest in the joint venture (e.g., are two venturers in a joint venture required to each have a 50% ownership interest in the joint venture)?
PwC response
No, the definition of a joint venture does not require that each investor have an equal ownership interest in the joint venture. However, care should be exercised when evaluating a joint venture when there is not equal ownership among the investors as that might indicate the venture does not meet the definition of a joint venture (e.g., there may be a lack of joint control among the venturers). For instance, significant differences in ownership interests among investors may raise questions as to why an investor with proportionately greater economic interest would permit lower economic interest investors to have the same level of participation over the significant decisions of the entity.
6.2.3 Other characteristics
In addition to joint control, there are other characteristics that must be met for an entity to meet the definition of a joint venture, as described in ASC 323-10-20. That is, joint control alone is not sufficient to obtain joint venture accounting. At the 2014 AICPA National Conference on Current SEC and PCAOB Developments, the SEC staff stated that each of the characteristics in the definition of a joint venture 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.
ASC 845-10-S99-2 states that the existence of joint control is not the only defining characteristic when determining whether an entity is a joint venture, rather, the other characteristics of a joint venture also need to be present. While the other characteristics might appear to be broad in nature and lacking specific guidance on how an entity would meet them (versus, for example, the joint control characteristic), an entity should exercise reasonable judgment in assessing whether it has met the additional characteristics. In making this assessment, the factors to consider include the purpose, nature, and operations of the entity.
For example, if the substance of a transaction is primarily to combine two or more existing operating businesses, which are either separate subsidiaries or divisions of a larger company, in an effort to generate synergies such as economies of scale or cost reductions and/or to generate future growth opportunities, such a transaction may be considered a merger that should be accounted for as a business combination under ASC 805 rather than as a joint venture. In this fact pattern, determining whether the purpose of the transaction is consistent with the definition of a joint venture as described in ASC 323 requires significant judgment.
Example EM 6-3, Example EM 6-4, Example EM 6-5, and Example EM 6-6 illustrate some of the accounting considerations when evaluating whether an entity meets the definition of a joint venture for accounting purposes.
EXAMPLE EM 6-3
Determining whether a joint venture is formed when each investor contributes its entire operations to a new entity
Determining whether a joint venture is formed when each investor contributes its entire operations to a new entity
Company A, a holding company, owns Company B, which has a fair value of $500 million, and represents all of Company A’s operations. Company C, a holding company, owns Company D, which has a fair value of $400 million, and represents all of Company C’s operations. Company A and Company C agree to combine their operating businesses in a newly established entity, Newco. Company A contributes Company B in exchange for 55% equity and joint control of Newco. Company C contributes Company D in exchange for 45% equity and joint control of Newco. Company A and Company C each have two members on the four member board of directors and unanimous approval from all board members is required for all decisions related to Newco. Other than joint control, none of the other characteristics of a joint venture as described in ASC 323 exist.
Does this arrangement meet the definition of a joint venture for accounting purposes?
Analysis
No. Newco does not meet the definition of a joint venture. Although the investors appear to have joint control, both investors have contributed their entire operations, and therefore would likely not meet the aspect of the definition that describes the purpose of a joint venture. This transaction was likely for the purpose of achieving economies of scale or cost reductions as opposed to the purpose of sharing risks and rewards in developing a new market, product, or technology; combining complementary technological knowledge; or pooling resources in developing production or other facilities.
EXAMPLE EM 6-4
Determining whether a joint venture is formed when one investor contributes a business and the other investor contributes cash to a new entity
Determining whether a joint venture is formed when one investor contributes a business and the other investor contributes cash to a new entity
Company A, a holding company, owns various businesses including Company B, which has a fair value of $500 million. Company A and Company C agree to form a joint venture, Newco, as they have plans for new product offerings and expansion into new markets. Company A contributes Company B in exchange for 50% equity and joint control of Newco. Company C contributes $500 million cash in exchange for 50% equity and joint control of Newco. The cash will remain in Newco to be used for ongoing operating expenses, developing new products, and developing new production facilities. Company A and Company C each have two members on the four member board of directors and unanimous approval from all board members is required for all decisions related to Newco.
Does this arrangement meet the definition of a joint venture for accounting purposes?
Analysis
Yes. Newco meets the definition of a joint venture for accounting purposes. Company A and Company C have each made contributions in exchange for joint control of the new entity. The purpose for the entity is consistent with that of a joint venture as the venture will use the cash invested by Company C to gain access to new markets and to develop new products.
EXAMPLE EM 6-5
Whether a joint venture is formed when one investor sells 50% of an existing operating subsidiary
Whether a joint venture is formed when one investor sells 50% of an existing operating subsidiary
Company A, a holding company, owns Company B, which has a fair value of $500 million, and represents all of Company A’s operations. Company A has decided to cash out a portion of its existing business. To facilitate the transaction, Company A and Company C agree to form a new company, Newco, which the two investors will jointly own and jointly control. Company A contributes Company B in exchange for 100% of the equity of Newco. Company C pays $250 million cash to Company A in exchange for 50% of its equity in Newco. Company A and Company C each have two members on the four member board of directors and unanimous approval from all board members is required for all decisions related to Newco.
Does this arrangement meet the definition of a joint venture for accounting purposes?
Analysis
No. While the investors have joint control over Newco, the substance of the transaction is that Company A has sold 50% of its business in exchange for cash. As the purpose of the transaction does not meet any of the other characteristics as described in ASC 323-10-20, this arrangement does not meet the definition of a joint venture for accounting purposes.
EXAMPLE EM 6-6
A joint venture structured in the form of a partnership
A joint venture structured in the form of a partnership
Company A and Company B form a new venture, Newco Partnership, a limited partnership. The general partner (GP) of Newco Partnership is Company C Corporation, a newly formed entity jointly owned and controlled by Company A and Company B. Company A owns 100% of Company A LLC, which has a 40% limited partnership interest in Newco Partnership. Company B owns 100% of Company B LLC, which has a 40% limited partnership interest in Newco Partnership. The GP owns the remaining 20% general partnership interest in Newco Partnership. The GP has the unilateral right to make all the decisions of Newco Partnership and the LPs do not have any participating rights or kick-out rights. Company A and Company B are not related parties.
Does Newco Partnership meet the definition of a joint venture?
Analysis
Yes. Assuming all of the other characteristics in ASC 323-10-20 are met, Newco Partnership would meet the definition of an accounting joint venture since Company A and Company B have joint control over the GP, which controls Newco Partnership. In this case, the substance of the arrangement is that the two companies have joint control over the joint venture.
6.2.4 Joint venture versus collaborative arrangements
Investors may enter into arrangements that are considered collaborative arrangements rather than joint ventures for accounting purposes. A collaborative arrangement is a series of contracts between two or more parties that involves a joint operating activity (e.g., marketing products), as described in ASC 808, Collaborative Arrangements. In many cases such arrangements do not include joint ownership in assets or a separate legal entity. Such arrangements are not joint ventures. See CG 8.3 for discussion of collaborative arrangements.
PwC. All rights reserved. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.
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