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6.4A Accounting by a joint venture (before adoption of ASU 2023-05)
Publication date: 30 Sep 2023
us Equity method of accounting guide
Prior to the issuance of ASU 2023-05, there was little authoritative guidance on accounting by a joint venture for contributed assets and liabilities. As a result, there has been diversity in practice, with some joint ventures accounting for contributions received at carryover basis and others at fair value.
6.4A.1 Initial contributions to the joint venture
Generally, noncash contributions to a joint venture are recognized by the joint venture at the lower of the investor’s carryover basis or fair value.
Prior to the issuance of ASC 810, Consolidation and ASC 610-20, Gains and Losses from the Derecognition of Nonfinancial Assets, both the investor (venturer) and the joint venture applied carryover basis when recognizing transactions involving the exchange of noncash assets for equity at formation, except in certain limited circumstances. The issuance of ASC 810 and more recently ASC 610-20 changed the accounting by the investor. Because the exchange of a business for a noncontrolling equity investment results in a loss of control over the business, ASC 810 acknowledges that this is a significant economic realization event that changes the nature of the retained noncontrolling investment. As a result, as discussed in EM 6.3.1.1, investors that transfer a subsidiary (or a group of assets) meeting the definition of a business generally recognize the initial equity investment at fair value. Similarly, ASC 610-20 requires the investor to record its investment in the joint venture at fair value when contributing nonfinancial assets or in substance nonfinancial assets that do not meet the definition of a business to the joint venture.
The resulting asymmetry in accounting basis between the investor and the joint venture created by ASC 810 and ASC 610-20 evoked a debate about whether it may be appropriate for the joint venture to also record the contributed business or nonfinancial assets at fair value. Given the changes to the investor’s accounting models, recent statements made by the standard setters have indicated that there may be instances when it may be appropriate to accept contributions being recorded at fair value at the joint venture level. As noted in EM 6.4, the FASB has an active project on this topic that may affect the accounting by the joint venture for the receipt of noncash assets at formation.
6.4A.2 SEC registrant joint ventures
The SEC staff has historically taken the view that the joint venture can elect to record the investor’s contributions at fair value only when all of the following conditions are met.
- Noncash assets are contributed by an investor into a newly formed venture and, after the transaction, the investor does not control the venture.
- The other investor contributes cash in an amount equal to the fair value of the noncash assets (fair value must be objectively determinable) contributed by the first venturer, and such cash remains in the joint venture or is used by the joint venture in transactions with parties other than the venturers.
- The investors have joint control over the joint venture.
- The investors are unaffiliated.
- Neither investor in the joint venture has preference in the allocation of equity or profits or losses (i.e., the profit split conforms to the ownership arrangement).
The SEC staff has also stated that a partial step-up in basis (to the extent that property has been “acquired” by the investor contributing cash) may be permitted in the following circumstances:
- Investor B acquires for cash a one-half interest in certain assets directly from Investor A. Both investors then contribute their interests in the assets to a new entity. Assume the new entity meets the definition of a joint venture as described in ASC 323-10-20.
- Investor A contributes certain assets to a new entity. Investor B acquires for cash a one-half interest in the new entity directly from Investor A. Assume the new entity meets the definition of a joint venture as described in ASC 323-10-20. (In the SEC staff’s view, this transaction is, in substance, the same as the first transaction and should be accounted for in a consistent manner.)
In these circumstances, the contributed property would be recorded on the books of the joint venture at 50% carrying value (Investor A’s carrying basis) and 50% fair value (Investor B’s carrying basis). A 100% step-up in basis to fair value has historically not been permitted, since cash was not contributed to the venture. A partial step-up would also be permitted in a scenario economically similar to the second circumstance, but where Investor B contributes cash into the joint venture and the cash is then distributed from the joint venture to Investor A.
The SEC staff has indicated that in certain limited circumstances, an investor’s contribution of recently acquired property from an independent third party could serve to validate the fair value of the other investor’s contributions and justify recording the joint venture’s assets at fair value.
The SEC staff has also stated that application of the above accounting guidelines to a joint venture with other than equal ownership (but joint control) would have to be evaluated on a case-by-case basis.
Example EM 6-9 illustrates joint venture accounting for tangible and intangible assets received upon formation of the venture.
EXAMPLE EM 6-9
Joint venture accounting for tangible and intangible assets received upon formation of the venture
Joint venture accounting for tangible and intangible assets received upon formation of the venture
Company A and Company B are unaffiliated entities that form an SEC-registered joint venture. Each investor has a 50% equity interest and joint control over the joint venture. Company A contributes a business from one of its divisions that has a net carrying value of $5 million and a fair value of $10 million. The $10 million includes $9 million for tangible assets and $1 million for identifiable intangible assets. Company B contributes $10 million in cash that will remain in the joint venture to fund operating expenses. The venture meets the other characteristics of a joint venture.
How should the contributed assets be recorded by the joint venture?
Analysis
Since the joint venture has met the SEC’s conditions for recognizing the contributions at fair value, the joint venture may elect to record total assets of $20 million — $10 million in cash, $9 million for tangible assets, and $1 million for the identifiable intangible assets. The joint venture may also record total assets of $15 million — $10 million in cash and $5 million for the business, since carryover basis is an acceptable measurement method upon formation of a joint venture.
Regardless of how the joint venture accounts for the contribution, Company A would record a gain upon losing control of a previously consolidated business following the guidance in ASC 810-10-40-5.
6.4A.3 Non-registrant joint ventures
Given the lack of guidance for the accounting for contributions received by a joint venture, entities generally look to the SEC guidance discussed in EM 6.4.1.1 in determining when fair value would be appropriate at the joint venture level.
Recording the investor contributions at carrying value in the nonregistrant joint venture financial statements continues to be appropriate, especially in the following scenarios:
- Noncash assets are contributed whose fair value is not readily determinable with a high degree of reliability, which may be the case when all investors contribute noncash assets.
- Noncash assets are contributed for which the recoverability of their fair value is in doubt. For example, internally developed intangible assets contributed to a joint venture will often be recorded at the investor’s basis (usually zero).
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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