New Definitions of an Investment Entity (IFRS) & Investment Company (US GAAP)

Background
International Financial Reporting Standards (IFRS): In October 2012, the International Accounting Standards Board issued Investment Entities – Amendments to IFRS 10 Consolidated Financial Statements, IFRS 12 Disclosure of Interests in Other Entities and IAS 27 Separate Financial Statements (the “Amendment”). This Amendment is compulsory for financial reporting periods beginning on or after 1 January 2014, with early adoption permitted, and requires retrospective adjustment of prior year comparative amounts where differences arise.

Accounting Principles Generally Accepted in the United States of America (US GAAP): In June 2013, the Financial Accounting Standards Board issued Accounting Standards Update No. 2013-08, Financial Services – Investment Companies – Topic 946 – Amendments to the Scope, Measurement, and Disclosure Requirements (ASU 2013-08). ASU 2013-08 is compulsory for financial reporting periods beginning on or after 15 December 2013, with early adoption prohibited, and requires prospective application whereby the net effect of initial application is presented as an adjustment to opening net assets in the financial reporting period of adoption.

Further to our recent article detailing the requirements of the Amendment (Global Regulatory Outlook, page 38, available at kinetic-partners.com), this article compares and contrasts the IFRS Amendment and US GAAP ASU 2013-08 to assess the degree of financial reporting convergence for investment
funds in particular.

Longstanding US GAAP has provided comprehensive accounting and reporting guidance for investment funds that generally requires fair value measurement (i.e. non-consolidation) of investments, including a controlling financial interest in an investee that is not an investment fund. However, the concept of industry specific guidance is new to IFRS and when following the Amendment, IFRS takes a large step in converging with existing US GAAP investment industry guidance whereby controlled investee funds are no longer consolidated, and required to be measured and presented as financial assets/liabilities at fair value, with changes in fair value recorded in the income statement.

Similar general definitions
IFRS and US GAAP have similar general definitions of an investment entity/company, namely pooling one or more investors’ monies, providing investment management services, and committing to a business purpose and sole substantive activity of investing for financial gain. Indicative characteristics typically include having: more than one investment; more than one investor; investors that are not related parties, and ownership interests in the form of equity or similar interests (e.g. partnership interests). Most investment funds will be included in these definitions.

Nuances in definitions
The IFRS definition also requires that the fund “measures and evaluates” the performance of substantially all of its investments on a fair value basis. US GAAP has a potentially lower hurdle in stating that the fund “manages” the performance of substantially all of its investments on a fair value basis. The US GAAP definition also includes any fund regulated under the Investment Company Act of 1940.

Common differences in disclosures
US GAAP continues to provide comprehensive guidance for funds within the scope of Accounting Standards Codification 946, which requires a schedule of investments, waives certain requirements to disclose prior year comparative amounts, waives certain requirements to present a cash flow statement, and requires disclosure of net asset values per share as well as financial highlights. US GAAP also continues to require that a feeder fund append the financial statements of a related master fund.

IFRS continues to avoid detailed investment industry specific guidance and only provides an exception from consolidation requirements for investment entities, whilst now permitting a feeder fund to append the financial statements of a related master fund rather than replicate otherwise identical financial statement disclosures.

Conclusion
Following adoption of the above more converged accounting rules, investment funds’ stakeholders will benefit from substantially increased comparability between US GAAP and IFRS financial reporting with more consistent recording of investments at fair value (without consolidation of controlled investee funds) which is generally the most relevant measurement attribute for users.

Less commonly, management of certain funds applying IFRS may nevertheless favor the presentation of voluntarily “combined” (rather than “consolidated”) financial statements, if they have reason to believe that maintaining consistent presentation provides more relevant information to users, perhaps in a situation where there is only one ultimate investor in a master-feeder structure for example.

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