The Boards continued their discussions from the February joint meeting in assessing how an investment company should account for its investments that it controls. At the February joint meeting the Boards agreed that an entity that is considered an 'investment company' should be exempted from consolidating entities that it controls and, instead, should measure investments in such controlled entities at fair value through profit or loss.
The Boards started their discussion by determining what indicators should be used to identify an investment company.
The Boards agreed that an investment company is an entity that met all of the following conditions:
- Express Business Purpose. The express business purpose of an investment company is investing for current income, capital appreciation, or both. The entity shall make a commitment, to a group of unrelated investors, that the purpose of the entity involves investing in assets, usually in the securities of other entities not under common management, in order to generate and distribute income, and/or capital appreciation, or both. An exit strategy must also be included in the investment plans.
- Investment activity. To meet the express business purpose requirement, substantially all of the entity's activities shall be investment activities carried out for the purpose of generating current income, capital appreciation, or both. Operating activities related to services provided to the entity do not preclude an investment company from meeting this criterion. To be an investment company, an entity must not obtain benefits from its investees that would be unavailable to other investors or unrelated parties of the investee.
- Unit Ownership. Ownership in the entity is represented by units of investments, such as shares of stock or partnership interests, to which proportionate shares of net assets can be attributed.
- Pooling of Funds. The funds of the entity's owners are pooled to avail owners of professional investment management.
- Fair value. All of the investments of the entity are managed, and their performance evaluated, on a fair value basis. Information about the entity's investments is provided internally on a fair value basis to the entity's key management personnel and externally on a fair value basis to its investors.
- Debt. Any providers of debt to the investees of the entity shall not have direct recourse to any of the entity's other investees.
The staff originally proposed that the entity must be a separate legal entity. Nonetheless, at the start of the meeting, the staff noted that it proposed to change that requirement to the definition of reporting entity (as defined in the exposure draft on Reporting Entity chapter of the Conceptual Framework). Several Board members strongly disagreed with that suggestion as they believed that such interpretation could lead to structuring opportunities - for example, divisions of multinational conglomerates would qualify for the fair value exception from consolidation. Other Board members did not share those concerns as they believed that the remaining conditions are rigorous enough to preclude such structuring (especially the unit ownership condition).
Finally, after significant level of discussion, the Boards agreed with the suggestion of one Board member to tie the reporting entity condition with the unit ownership condition. For the staff the elimination of separate legal entity condition was important as the staff believed that such condition could preclude the usage of the exception by some unit trusts. On the other hand, some Board members were extremely concerned with unintended consequences of such change. One Board member even suggested that such a decision might lead to introduction of the legal isolation concept by the back door.
The Boards decided to include several additional requirements to the list of conditions for classification as an investment company. Those additional requirements included an explicit condition related to substantial investments by outside investors, prohibition of usage of call and put options, and better articulation of the range of companies that are considered to be affiliates to the entity.
The Boards also considered the scenario in which the parent company directly owns a share in an entity (such as 25%) and owns the remaining 75% through investment companies that are measured at fair value. The Boards considered how to adjust the balances on consolidation, or alternatively whether to scope out investment companies from the fair value exception proposed when the ultimate parent owns partial interest in the investments held by the investment company. Finally, the Boards decided that they needed to consider the consequences of the fair value exemption on consolidation adjustments more broadly (for example, intra-group sales, intra-group loans, etc).
Nonetheless, several Board members remained concerned that the new guidance would be subject to structuring and would not fulfil the objectives the Board expected.
The Boards also clarified that all investments that fulfil the criteria would be measured at fair value through profit or loss.
The Boards considered the consequences on the accounting by the parent of the investment company. Several Board members supported the guidance that parent entity would not be permitted to retain fair value accounting for any controlled investees of an investment company subsidiary in the parent's consolidated financial statements. Those Board members believed that only such restriction would eliminate the structuring opportunities.
On the other hand, the majority of the Board believed that it would be appropriate to retain the accounting for an investment company subsidiary if a parent has multiple separate activities (that is, report investment activities at fair value and consolidate operating activities). The Boards agreed that when the information is relevant and useful on the investment company level it would be useful also on the parent level.
Finally, the Boards clarified that involvement of the management company in management of the investees (for example, representation on the Board level) is consistent with the definition of the investment company.
The Boards agreed that an entity that previously was not considered an investment company, but met the revised definition of an investment company, should report the effect of the change in status as of the date that they first applied the revised consolidation requirements as an adjustment to retained earnings in the period in which the change occurred. The adjustment to retained earnings would represent the difference between the previous carrying amount of the net assets of the investee and the fair value of the investee as of the date of first applying the new consolidation requirements.
The staff noted that the IASB plans to publish a limited exposure draft of guidance related to investment companies. Even though the Board did not officially vote, several Board members indicated that they intend to dissent from that ED and would present an alternative view.
The Boards will continue their discussions on disclosure requirements at later sessions.