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Key Takeaways
- The newly issued Accounting Standard Update 2023-05 provides specific guidance on how to account for assets contributed and liabilities assumed in a joint venture formation.
- The amendments in the ASU are effective for joint ventures formed on or after January 1, 2025. Early adoption is permitted.
- There are crucial differences between the JV formation accounting outlined in 2023-05 and traditional business combinations. Understanding these nuances is essential to applying the new standard effectively.
The Financial Accounting Standards Board (FASB) recently issued an update on accounting for a newly formed joint venture (JV), including how the JV should initially measure assets contributed and liabilities assumed.
Previously, there was no authoritative guidance addressing this issue, which has resulted in diversity in practice. Some entities have measured the assets contributed and liabilities assumed at the venturers’ existing carry values, while others have used a fair value approach.
The new standard, Accounting Standard Update 2023-05, Business Combinations – Joint Venture Formations (Subtopic 805-60) – Recognition and Initial Measurement (the ASU) lays out guidance on the subject to reduce diversity in practice and provide more decision useful information to investors. The amendments in the ASU resulted in the addition of Accounting Standards Codification (ASC) Subtopic 805-60 Joint Venture Formations as well as some clarifying and conforming amendments in various other ASC topics.
Effective Date and Transition Considerations
The amendments in the ASU become effective for all JVs formed on or after January 1, 2025. A JV formed before January 1, 2025, may elect to apply the amendments retrospectively.
Early adoption is permitted in any interim or annual period in which financial statements have not yet been issued.
Scope and Applicability of ASU 2023-05
The amendments in the ASU affect the accounting for contributions received upon formation by entities that meet the definition of a Joint Venture or a Corporate Joint Venture, as defined in the Master Glossary of the FASB ASC. Accordingly, practitioners must carefully apply relevant facts and circumstances in determining whether an entity meets the definition of a JV or corporate JV before proceeding further in the guidance.
Furthermore, the guidance in the newly created ASC Subtopic 805-60 does not apply to:
- Transactions between a JV and its owners, other than the formation of a JV.
- Entity formation determined to be nonprofit entities in accordance with Topic 958.
- Combinations between entities, businesses, or nonprofit activities under common control.
- Entities in construction or extractive industries that may be proportionately consolidated by their investor-venturers in accordance with FASB ASC 810-10-45-14.
- Collaborative arrangements within the scope of FASB ASC 808, except for any part of the arrangement conducted in a separate legal entity that meets the definition of a joint venture.
Similarities Between Joint Venture Formation Accounting and Existing ASC 805 Guidance
Under the provisions of the ASU, an entity formed into a JV will apply a new basis of accounting as of the JV’s formation date. As a result, the newly formed JV should initially measure the fair value of the JV at the formation date and then allocate that value to the contributed assets and liabilities based on their respective fair values. Certain exceptions may apply to fair value measurement consistent with the business combinations guidance.
Goodwill is recognized for the amount by which the fair value of the JV exceeds the aggregate fair values of the identified assets and liabilities contributed.
This approach of recording assets and liabilities at their fair values is generally consistent with other new basis of accounting models, such as fresh start reporting under Topic 852, Reorganizations. It is also broadly consistent with the outcome that would result from treating the JV as the acquirer of a business within the scope of ASC 805-10 Business Combinations – Overall. Goodwill at the initial formation of the JV is measured as the excess of the fair value of the JV as a whole over the fair value of the identified assets contributed and liabilities assumed.
Differences Between JV Formation Accounting and Existing ASC 805 Guidance
No Acquirer
When accounting for a newly formed JV, there is no identified acquirer and therefore no acquisition date. This means recognition and measurement occur on the formation date of the joint venture.
Formation date is a new concept specific to joint venture formations under this ASU, and is defined in the ASC Master Glossary as:
“…the date on which an entity initially meets the definition of a joint venture, which is not necessarily the legal entity formation date. The formation date is the measurement date for the transaction. If multiple arrangements are accounted for as a single transaction that establishes the formation of a joint venture, the formation date is the measurement date for all arrangements that form part of the single formation transaction.”
Measurement of Goodwill
In a business combination, goodwill is recognized for the amount of consideration transferred in excess of the fair value of identified assets and liabilities acquired. However, in a JV formation, consideration transferred is not a relevant concept since there is no acquirer – this necessitates a different mechanism for measuring goodwill.
In a JV formation, goodwill is measured as the excess of the fair value of the JV as a whole (e.g., the fair value of the JV’s equity) over the fair value of the identified assets contributed and liabilities assumed. In circumstances where the fair value of the JV as a whole is less than the aggregate fair values of the identified assets contributed and liabilities assumed, there is no gain recorded on formation, rather an adjustment to additional paid-in capital, or similar equity account.
Business vs. Assets Contributed
Goodwill recognition at JV formation follows the measurement guidance, whether or not the newly formed JV or the net assets contributed to the JV upon formation meets the definition of a business in accordance with ASC 805. However, it is not expected that more than an insignificant amount of goodwill will be generated if the JV does not meet the definition of a business. Accordingly, there could be instances where minor amounts of goodwill are created in a JV formation, even if the JV or the net assets contributed do not meet the definition of a business.
Contingent Arrangements
If liability or asset-classified contingent arrangements are present at JV formation, they shall be measured under ASC 805-20 guidance instead of ASC 805-30. This is because the entity’s total net assets (including goodwill) are measured based on the JV upon formation instead of consideration transferred.
ASC 805-20 provides that assets or liabilities arising from contingencies shall be measured at fair value if the acquisition-date fair value can be determined during the measurement period. If the fair value cannot be determined during the measurement period, the liability or asset is only recognized at the acquisition date if information before the end of the measurement period indicates it is probable an asset existed, or a liability was incurred at the acquisition date. Further, the amount must be reasonably estimable. Liability-classified replacement share-based payment awards shall initially be measured using the fair-value-based measurement method described in ASC 718 Compensation – Stock Compensation.
Equity Classified Instruments
The amount of any separately recognized equity-classified instruments and contracts issued by a JV formation will not increase total net assets, goodwill, or equity. Instead, they will be accounted for as a reallocation of APIC or another similar equity account. This is because consideration transferred is not a concept in JV formation accounting. Therefore, the fair value of these separately recognized equity instruments would theoretically already be included in the measurement of the fair value of the JV as a whole.
Equity-classified replacement share-based payment awards shall be measured using a fair value-based measurement method described in ASC 718 and allocated between pre-formation vesting and post-formation compensation cost. The amount allocated to pre-formation vesting will be accounted for as a reallocation of equity, while amounts relating to post formation compensation cost are recognized as compensation cost over the applicable service period.
In Process Research and Development (IPR&D)
Contributed tangible and intangible IPR&D assets should be measured at fair value and capitalized upon formation of the JV, regardless of whether those assets have an alternative future use or whether the JV meets the definition of a business or not. Intangible IPR&D will be accounted for as indefinite-lived intangible assets until the completion or abandonment of the associated research and development efforts. Contributed tangible IPR&D assets will be accounted for in accordance with their natures.
Acquisition Costs and Settlement of Pre-Existing Relationships
Existing ASC 805 guidance for pre-existing relationships and acquisition-related costs is irrelevant in the context of a JV formation because the JV does not exist before the formation date. Accordingly, the ASU specifically prohibits a JV from applying by analogy the guidance in ASC 805-10 for settling a pre-existing relationship and accounting for acquisition-related costs.
Disclosure Requirements
Disclosure requirements for the formation of a JV include the following:
- The formation date.
- A description of the purpose for which the JV was formed.
- The formation date fair value of the JV as a whole.
- A description of the assets and liabilities recognized by the JV at the formation date.
- Amounts recognized at the formation date for each major class of asset.
- A qualitative description of the factors that make up any goodwill recognized.
Additional disclosures are required if the initial accounting for a JV formation is incomplete.
Other Items of Note in ASU 2023-05
Private Company Accounting Alternatives
A JV that is a private company may apply the accounting alternative available to private companies to not separate customer-related intangibles and non-compete agreements from goodwill per ASC 805-20-25-30 and 33.
A JV that makes this election must also adopt the accounting alternative for amortizing goodwill in the accounting alternatives subsections of ASC 350-20. Electing these alternatives will reduce some of the cost and complexity of accounting for the JV's formation.
Measurement Period
A newly formed JV may apply the measurement period guidance from Subtopic 805-10 if the initial accounting for a JV formation is incomplete by the end of the reporting period in which the formation occurs.
Next Steps with ASU 2023-05
If you previously accounted for the formation of a JV or if you will be involved in an upcoming JV formation, ASU 2023-05 provides some clarity. Venturers should consider whether early adoption of the ASU’s amendments is beneficial for the separate financial statements of their JV.
Whether to early adopt the amendments in the ASU may largely depend on the needs and interests of the financial statement users and owners, including consideration of future plans that the venturers may have for the JV, as well as cost/benefit, and administrative factors.
For example, if the venturers plan to eventually sell the JV and early adoption of the amendments in the ASU would result in a favorable impact on the company’s financial position, early adoption (and retrospective application when applicable) may be something to look further into.