Accounting for equity interests other than the consolidation model

Fund managers are typically responsible for the preparation of financial statements of their underlying investment, in accordance with Accounting Standards Codification (ASC) 946 – Financial Services – Investment Companies, which requires the valuation of investments under ASC 820 – Fair Value Measurements.

Please note that this topic excludes interests that are required to be consolidated under ASC Topic 810 – Consolidation.

Accounting under ASC 820

Because it is common for fund managers to hold an interest in these funds, it is common for the manager to consider accounting for the interest by applying the proportional fair value method, which may be the equivalent of using net asset value as a practical expedient. This is a permissible valuation methodology, subject to certain requirements, under ASC 820.

However, ASC 820 is in scope only if another U.S. Generally Accepted Accounting Principles (GAAP) topic permits the use of fair value measurements (ASC 820-10-15-1). Unlike an investment company accounted for under ASC 946, ASC 820 is not the initial prescribed treatment for an operating business. Because of this, entities will account for interests under ASC 820 only if other guidance allows them this treatment.

Considering equity method and joint ventures

The topic that should first be considered is ASC 323 – Equity Method and Joint Ventures – Sub-topic 323-30 – Partnerships, Joint Ventures and Limited Liability Entities, which governs accounting for investments in partnerships and similar vehicles.

Under the equity method in accordance to GAAP, an investor recognizes its share of the earnings or losses on an investee in the periods for which they are reported in its financial statements. It is important to note that this method typically results in a value substantially consistent with use of the net asset value as a practical expedient. Consequently, this evaluation is not expected to have a material effect on reported results, but will effect an entity’s required disclosures.

Significant influence

Fund managers generally need to account for their investments using the equity method if the investor has the ability to exercise “significant influence.” Significant influence is defined under 323-10-15-6 as the ability to exercise significant influence over operating and financial policies of an investee, which may be indicated in several ways:

• Representation on the board of directors
• Participation in policy-making processes