In August 2023, FASB issued Accounting Standards Update (“ASU”) 2023-05-Business Combinations–Joint Venture Formations (Subtopic 805-60): Recognition and Initial Measurement. Prior to issuance of this ASU, there was no authoritative guidance in U.S. GAAP that discussed how a joint venture (JV) should recognize the initial contribution upon formation. As a result, this led to diversity in practice, where some JVs were recognizing the initial contribution using a carryover basis, and some were using a fair value (FV) basis. This ASU is intended to reduce diversity in practice and provide users of the financial statements with useful and relevant information. The new guidance does not impact venturers’ accounting, who are required to recognize the initial contribution at FV. In the past, prior to issuance of this ASU, this often created basis differences if the venturer used FV basis, and the JV used a carryover basis. This ASU will eliminate these differences.
A JV is required to recognize net assets contributed in a formation of a JV at fair value at the formation date (the date when JV meets all the criteria for JV), which is not necessarily the legal entity formation date. It is important to note that the definition of a JV did not change, and it has to satisfy the same requirements as in the past (joint control over management decisions, active participation, and mutual benefits) in order to qualify as a JV. ASU 2023-05 applies only to the initial formation contribution, and not to subsequent accounting and recognition for JVs. The formation date is the date the entity initially meets the definition of a JV.
ASU 2023-05 provides guidance on combining two or more transactions as a single transaction on a formation date. If multiple arrangements are combined as a single transaction, the formation date is the measurement date for all arrangements that form part of the single formation transaction. This could cause differences between the measurement date and recognition date in instances where assets are contributed any time after the initial formation date.
While some may belief that the new requirements for FV measurement could add additional incremental cost to determine the fair value of the JV as a whole, FASB believes that joint venturers could leverage the FV measurements from the venturers’ accounting (who are required to record contribution at a FV) to reduce the overall compliance cost of applying FV.
Regardless if contributions received represent business or assets, goodwill will be recognized if FV of JV as a whole exceeds FV of net assets contributed. A JV that is a private company can apply private company accounting alternative for recognizing identifiable intangible assets. If the private company alternative is elected, the JV also has to elect the accounting alternative for amortizing goodwill on a straight line basis over 10 years (or a shorter period if applicable).
The ASU requires certain disclosures in JV’s financial statements in order for users to better understand the nature and financial effect of the JV formation. Required disclosures include the following:
ASU 2023-05 applies to any new joint ventures formed on or after January 1, 2025, with early adoption permitted. This ASU will be adopted on a prospective basis. However, retrospective adoption is also allowed for a JV formed prior to January 1, 2025, and if sufficient information is available.
Contact us to learn more about Joint Venture Formation Changes Effective January 2025.