The Financial Accounting Standards Board (FASB) issued an Accounting Standards Update (ASU) which amends the criteria that define an investment company, clarifies the measurement guidance, and requires new disclosures. The ASU arose from collaboration between FASB and the International Accounting Standards Board (IASB) to develop a consistent approach to recognizing entities as investment companies. The ASU will go into effect for fiscal years that begin after December 15, 2013 (2014 for entities with calendar year-end) for all interim and annual reporting. Early application of the ASU is prohibited.
Overview of New Criteria
In developing the ASU, the Board concluded that an entity claiming to be an investment company must possess certain fundamental characteristics. There also exist some ancillary characteristics that, although consistent among most investment companies, are not required for investment company status. It is also important to note that if an entity is already regulated under the Investment Company Act of 1940, it is automatically considered to be an investment company consistent with the ASU.
The three fundamental characteristics that are required for Investment Company Status under the ASU are as follows:
- The entity obtains funds from, and provides investment management services to, one or more investors.
- The entity commits to its investor(s) that its business purpose and only substantive activities are investing solely for returns from capital appreciation, investment income, or both.
- The entity does not obtain or have the objective of obtaining returns or benefits from an investee or its affiliates that are not normally attributable to ownership interests or that are other than capital appreciation or investment income.
Additional characteristics that are not required but typical of compliant investment companies include:
- More than one investment.
- More than one investor.
- Investors are not related parties of the parent (if any) or the Investment Manager.
- Ownership interests in the form of Equity or Partnership Interests. This characteristic is highly valued by the Board because it justifies and promotes measuring investments at fair value.
- Management of substantially all investments on a fair value basis. When measuring and analyzing performance, an investment’s fair value is critically important. The Board recognizes that fair value management can be performed through various methods. Whether it’s through analyzing performance, evaluating investment decisions, or transacting with investors, the use of fair value for an entity’s investments is crucial.
Valuation and Balance Sheet Implications
There are valuation and balance sheet implications for companies no longer considered as an investment company as well as those that meet the new criteria.
For corporations that no longer meet the criteria and have controlling interest investments (previously valued at fair value), it is likely that the investments may have to be re-evaluated pursuant to purchase price allocation rules of ASC 805, Business Combinations (formerly FASB Statement No. 141R) and/or International Financial Reporting Standards (“IFRS”) IAS 3 (revised): Business Combinations. If so, these companies may find their auditors requiring a restatement of historical financial statements back to the date of the initial investment. Further, the identified goodwill per the ASC 805/IAS 3 analyses may be subject to subsequent testing for goodwill impairment, at least annually, pursuant to ASC 350, Intangibles – Goodwill and Other (formerly FASB Statement No. 142) or IAS 36, Impairment of Assets.
For companies that meet the criteria as an investment company, the ASU maintains that investment companies must measure their investments at fair value with any changes in fair value being reported on the statement of operations. Furthermore, the ASU states that if an investment company possesses non-controlling interest in other investment companies, the non-controlling interest must be measured at fair value. The equity method of accounting for interests in other investment companies is no longer permitted.
As noted, fair value is a critical measurement when reclassifying a company’s status, accounting for interest in another company, and presenting investment performance. We believe that investment companies can ensure compliance with regulations by utilizing independent, third party valuation firms.
Houlihan Capital
Houlihan Capital can provide critical valuation information to Investment Companies by providing independent valuations, which can supply the necessary support and documentation to stand up to FASB and other regulatory scrutiny. Houlihan Capital has a history of working closely with clients’ management, regulators, auditors, legal counsel, and investors on financial reporting and tax compliance matters. For more information on independent third party valuation services, please visit www.houlihancapital.com or contact Paul Clark (pclark@houlihancapital.com) at 312‐450‐8656.
Houlihan Capital is a leading, solutions-driven valuation, financial advisory, and boutique investment banking firm committed to delivering superior client value and thought leadership in an ever-changing landscape. The firm has extensive experience in providing fairness and solvency opinions, and objective, independent, and defensible opinions of value that meet accounting and regulatory requirements. Our clients include some of the largest asset managers, private equity funds, hedge funds, fund administrators, and both public and private operating companies, who benefit from our comprehensive valuation and financial advisory services. Houlihan Capital is a Financial Industry Regulatory Authority (FINRA) and SIPC member, and is SOC-compliant. In short: Value. Added.
