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Investment entities

Date recorded:

The Boards continued their re-deliberations of their respective proposals on investment entities.


Accounting by an investment entity parent for an investment entity subsidiary

The Boards discussed the accounting by an investment entity parent for an investment entity subsidiary under two separate scenarios. The first scenario was that of a master-feeder fund structure where a feeder fund’s only investment would be in a master fund (typically two feeder funds invest in a master fund and are all managed under a common control structure) which actually holds the underlying investments. The second scenario was that of a fund-of-funds structure where an investment fund may invest in numerous other investment funds (some funds may be managed by the investment manager while other funds may be managed by third-party investment managers).

The IASB’s exposure draft proposed that investment entities would measure all controlled investees at fair value, regardless of whether the investee is an operating entity or an investment entity (unless the entity provides services to the investment entity). The FASB’s exposure draft proposed that investment entities would consolidate controlling financial interests in a fund-of-funds structure but that a master-feeder structure would be measured at fair value because current practice includes attaching master fund financial statements to the financial statements of a feeder fund which provides transparency in to the investment activity for investors in the feeder fund.

Constituents generally disagreed with the FASB’s proposals regarding consolidation of a fund-of-funds structure as doing so would distort the financial statements. Constituents felt that the FASB’s concerns regarding transparency could be addressed through expanded disclosures rather than consolidation.

The staffs recommended that for master-feeder structures the feeder fund should not consolidate a controlling financial interest in a master fund and instead should record its interest in the master fund at fair value. Additionally, all feeder funds should include master fund financial statements along with those of the feeder fund. For fund-of-funds structures, the staffs recommend that an investment entity measure all investment entity subsidiaries at fair value.

Many IASB members referenced the scope of the IASB project as providing an exception to consolidation for investment entities but not providing investment entity guidance and questioned the recommendation about requiring an entity to provide financial statements for a subsidiary as being outside of their scope. Some IASB members felt that a requirement to attach subsidiary financial statements was a regulatory issue rather than an accounting standard setting issue. However, other IASB members felt that requiring disclosures when providing an accounting exception was perfectly within the scope of the project.

The FASB members generally supported the staff recommendation but questioned whether defining master-feeder structures and requiring the inclusion of master fund financial statements would require re-exposure. The FASB members raised the issue that without the inclusion of master fund financials a feeder fund financial statement would essentially be only a one line item balance sheet and income statement. One FASB member questioned why the proposals should be different between a master-feeder and a fund of funds structure and suggested that fund-of-funds structures should be required to attach financial statements for any investment material.

The IASB tentatively decided to retain the proposals in their exposure draft that an investment entity would account for all investments at fair value except for those controlled entities that provide services to the entity which would be consolidated. The IASB also tentatively decided not to require the inclusion of investment entity subsidiary financial statements but would consider the issues on transparency as part of the disclosure discussions during a future meeting.

The FASB also tentatively decided that an investment entity would account for all its investments at fair value except for those controlled entities that provide services to the entity (and investment properties which is being re-deliberated in a separate project) which would be consolidated. The FASB also tentatively decided to require a feeder fund to include the financial statements of a master fund as part of its financial statements. The FASB highlighted that they would need to consider their decision on fair value accounting for controlled investment entities and any conflicts with the requirements under the SEC’s 1940 Act and that they would also need to define a master-feeder structure at a future FASB-only meeting.


Accounting by a non-investment entity parent for the investments of an investment entity subsidiary

The IASB’s exposure draft proposed that a non-investment entity parent would be required to consolidate all entities it controls including those controlled through an investment entity. In other words, a non-investment entity parent who consolidates an investment entity, would not be allowed to retain the fair value accounting for the investment entities investments at the non-investment entity parent level. The IASB’s exposure draft referenced potential accounting inconsistencies and the potential for abuse.

The FASB’s exposure draft retained the existing practice in US GAAP for a non-investment entity parent to retain the specialised accounting of a consolidated subsidiary (i.e. carryover fair value accounting at the parent level).

Nearly all FASB constituents and the majority of IASB constituents supported the US GAAP approach of retaining fair value accounting of an investment entity in consolidation by a non-investment entity parent. These constituents felt that the specialised accounting by the investment entity continues to be relevant at the non-investment entity parent level, that the cost savings and benefits of more relevant reporting would be lost if fair value accounting was not retained, and that retention of fair value would be consistent with the IASB’s proposals for non-investment entity parents’ interests in associates and joint ventures. They also felt that the IASB’s concerns regarding the potential for structuring were overstated and could be addressed through the criteria to qualify as an investment entity.

The staffs considered an alternative between the two Boards’ proposals which would require only some non-investment entity parents to retain the specialised accounting (for example, entities with characteristics of investment entities but did not qualify because they also include other activities). However, the staff viewed such an approach as being over complex.

One IASB member noted that fair value information regarding investments provides more relevant information and that holds true at the parent level. However, other IASB members expressed concern over the retention of fair value accounting. One IASB member referred to a section of the agenda paper discussing the revised definition of an investment entity (as tentatively decided at the May joint Board meetings) which stated that an investment entity and its affiliates cannot obtain any returns or benefits from their investments other than capital appreciation or capital appreciation and investment income and therefore this would prevent investment funds from qualifying as investment entities if the parent were to also receive other benefits. He questioned the staffs how much of a constraint the revised definition provided. The staffs had differing views on the question, the FASB staff felt that this was sufficient as it would scope out those instances of non-investment entity parents avoiding consolidation but receiving benefits such as supply chain, research and development or other benefits. However, the IASB staff viewed the revised definition of an investment entity as expanding the population of those entities within the scope of the investment entity definition.

The FASB tentatively decided to require retention of fair value accounting by a non-investment entity parent of an investment entity. The IASB tentatively decided to require non-investment entity parents to consolidate all entities they control, even when held through an investment entity.

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