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Accounting for the formation of joint ventures

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Almost all of the existing accounting literature focuses on how the parties to a joint venture – known as venturers – should account for their interests in a joint venture, rather than focusing on the accounting by the joint venture itself in its own separate financial statements.

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A question often arises about how the joint venture should recognize and measure noncash assets received from the venturers at formation of the joint venture. Currently, no authoritative guidance exists that provides a direct answer on this issue.

A joint venture is an entity owned and operated by a small group of businesses as a separate and specific business or project for the mutual benefit of the members of the group. While defined in a similar manner as a corporate joint venture, a joint venture is not limited to corporate entities.

Joint ventures involve the creation of a separate legal entity. They are different from collaborative arrangements, jointly controlled operations and jointly controlled assets, in which activities normally are not conducted through a separate entity, like a corporation or partnership. Collaborative arrangements are accounted for in accordance with FASB ASC 808, Collaborative Arrangements.

Historically, the general practice has been that the joint venture measures the contributed assets on a carryover basis. Thus, the basis in the assets of the venturers becomes the basis in the assets of the joint venture.

This approach has largely rested on the fact that the joint venture formation does not result in the culmination of the earnings process. Therefore, a new basis – for example, use of fair value – was not appropriate.

Recently, views on this area of accounting have been evolving. More use of fair value to determine the basis of the contributed assets, rather than carryover basis, is being noticed when the parties to the joint venture are not related parties.

More specifically, the use of fair value is becoming more acceptable when the contributed assets to a joint venture constitute a business. The use of fair value as a new basis for the joint venture often results in gain recognition on the part of the venturers.

Support for the use of fair value has been gaining as the general use of fair value accounting has been increasing in other areas of U.S. generally accepted accounting principles (U.S. GAAP). And use of fair value in joint venture accounting would be consistent with other areas of U.S. GAAP, like accounting for business combinations using the requirements and guidance in FASB ASC 805, Business Combinations.

The use of the carryover basis has been the more commonly used historical practice by the joint venture for the assets received at formation. But the use of fair value is not prohibited by the authoritative literature, especially in light of the fact that authoritative literature in this area does not clarify whether the carryover basis or fair value accounting would be the appropriate measurement goal.

Essentially, a couple of alternatives exist related to accounting by the joint venture for assets received at formation when the parties forming the joint venture are not related parties – carryover basis and fair value. And fair value is really an alternative only if the assets transferred constitute a business.

Private companies have traditionally used carryover basis, and financial statement preparers should carefully evaluate the facts and circumstances of the formation of a joint venture when deciding upon the appropriate accounting.

Since there is no authoritative guidance on which method to use, the entity should disclose the method used – whether carryover basis or fair value – to value the assets and liabilities of the joint venture in the summary of significant accounting policies note to the financial statements.

Also, given the lack of authoritative guidance, this issue would be an area where judgment and estimates were applied. Transparent disclosures would be needed to ensure that users of financial statements have the information they need to make appropriate decisions.

In private company financial reporting, it is not uncommon for related parties to form joint ventures, especially in the startup arena. In these situations, carryover basis should be used to account for the assets received by the joint venture at formation.

The assumption is that transactions between related parties are not arm’s-length transactions. Therefore, it would not be appropriate to use fair value because those values are not reflective of the transaction.

Although not specifically addressed for joint ventures, under FASB ASC 805, when there is a business combination between entities under common control, and when those entities are related parties, fair value measurements of assets and liabilities assumed would be prohibited. By Thomas A. Ratcliffe, CPA, CGMA, Technical Director, AICPA Center for Plain English Accounting