FASB clarifies characteristics of investment companies

A FASB standard released Friday identifies characteristics a company must assess to determine whether it is considered an investment company for financial reporting purposes.

Accounting Standards Update No. 2013-08, Financial Services—Investment Companies (Topic 946): Amendments to the Scope, Measurement, and Disclosure Requirements, takes effect for fiscal years beginning after Dec. 15, 2013. Earlier application is prohibited.

The standard says that companies regulated under the Investment Company Act of 1940 are investment companies for accounting purposes. All other companies must study a list of characteristics to determine whether they are investment companies for accounting purposes.

The list for companies to consider contains the following characteristics:

a. The company obtains funds from investor(s) and provides the investor(s) with investment management services.

b. The company commits to its investor(s) that its business purpose and only substantive activities are investing the funds for returns solely from capital appreciation, investment income, or both.

c. The company or its affiliates do 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.

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d. The company has multiple investments.

e. The company has multiple investors.

f. The company has investors that are not related to the parent or investment manager.

g. The company’s ownership interests are in the form of equity or partnership interests.

h. The company manages substantially all of its investments on a fair value basis.

To be an investment company, a company must have all the fundamental characteristics of items a through c, according to the standard. An investment company also typically has characteristics d through h, according to FASB.

If a company does not possess one or more of the typical characteristics (d through h), it must apply judgment to determine whether its activities continue to be consistent (or inconsistent) with those of an investment company.

“Investment companies have reported their investments at fair value for decades under U.S. GAAP, and this standard does not change that basic principle,” FASB Chairman Leslie Seidman said in a news release. “However, over the years, different types of companies have engaged in investing activities, making that guidance less clear. This standard clarifies the characteristics of an investment company and provides comprehensive implementation guidance.”

The standard will require an investment company to measure noncontrolling ownership interests in other investment companies at fair value rather than using the equity method of accounting. An investment company also will be required to disclose:

• The fact that it is an investment company and is applying specialized guidance;
• Information about any changes in the company’s status as an investment company; and
• Information about financial support provided or contractually required to be provided by an investment company to any of its investees.

FASB’s approaches to investment company assessment are similar to those of the International Accounting Standards Board, which issued Investment Entities (Amendments to IFRS 10, IFRS 12 and IAS 27) last October.

But the scope of investment company guidance under IFRS is narrower because it provides only an exception to consolidation guidance. For a company to be eligible for the investment entity exception to consolidation guidance, IFRS requires a controlled investee to be present.

U.S. GAAP, on the other hand, has long provided comprehensive accounting and reporting guidance for investment companies.

—Ken Tysiac (ktysiac@aicpa.org) is a JofA senior editor.