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Consolidation — Investment Entities

Date recorded:

At the May 2012 meeting, the Boards tentatively decided that an entity would be required to meet a definition and also to consider additional factors to determine whether it is an investment company.

To date, the IASB has tentatively decided that the definition of an investment entity would be as follows:

  1. An investment entity does all of the following:
    1. Obtains funds from an investor or investors and provides the investor(s) with professional investment management services
    2. Commits to its investor(s) that its business purpose and only substantive activities are investing the funds for returns from capital appreciation or capital appreciation and investment income
    3. Manages and evaluates the performance of substantially all of its investments on a fair value basis.
  2. An investment company and its affiliates do not obtain, or have the objective of obtaining, returns or benefits from their investments that are either of the following:
    1. Other than capital appreciation or capital appreciation and investment income
    2. Not available to noninvestors or are not normally attributable to ownership interests.

To date, the FASB has tentatively decided that the definition of an investment company would be as follows:

  1. An investment company is an entity that does both of the following:
    1. Obtains funds from an investor or investors and provides the investor(s) with professional investment management services
    2. Commits to its investor(s) that its business purpose and only substantive activities are investing the funds for returns from capital appreciation, investment income, or both.
  2. An investment company and its affiliates do not obtain, or have the objective of obtaining, returns or benefits from their investments that are either of the following:
    1. Other than capital appreciation or investment income
    2. Not available to other noninvestors or are not normally attributable to ownership interests.

The FASB also tentatively decided that the concept of managing on a fair value basis would be a factor that an entity would consider to determine whether it is an investment company (whereas the IASB decided that fair value would be part of the definition of an investment entity). That assessment would consider how the entity manages and evaluates the performance of its investments, how the entity transacts with its investors, and how asset-based fees are calculated to determine whether the entity manages its investments on a fair value basis.

The Boards also discussed whether an entity should consider the following factors to be an investment company and asked the staff to investigate how these factors would interact with the definitions noted above:

  • Number of investments and investors
  • Whether the investors are related parties
  • Unit ownership

At the July 2012 meeting, the Boards discussed which alternative it would prefer regarding the relationship of the definition of the factors to be an investment company:

  1. Alternative 1: Do not require an entity to meet one or more of the factors to be an investment entity.
  2. Alternative 2: Require an entity to meet at least one factor to be an investment entity. However, this required factor need not be specified.
    1. If an entity meets only the ‘number of investments’ factor, it should be required to have multiple substantive investments;
    2. If an entity meets only the ‘number of investors’ factor, it should be required to have multiple substantive investors.
  3. Alternative 3: Amend the definition to require an entity to have a significant ownership interest held by an investor that is not related to the investment manager or investors not related to the parent entity.

The staff noted that there is an emphasis that irrespective of the alternatives, if an entity did not meet a factor – it would be required justify how it continues to meet the definition to be an investment company.

The IASB tentatively decided that unit ownership should not form part of the definition of the investment entity but rather be a feature or characteristic (i.e., as part of application guidance).

The IASB noted that the terminology ‘factors’ was not part of the IFRS vocabulary and that such ‘factors’ should not form part of the definition of an investment entity but rather as characteristics or features (i.e., as part of the application guidance). The Board tentatively supported Alternative 1 and one of the Board members suggested a rewording of the definition of the investment entity and application guidance (which was tentatively supported by the Board, subject to further drafting/editorial changes).

The draft suggestion is that an investment entity is an entity that:

  1. Obtains funds from one or more investors for the purpose of providing investor(s) with professional investment management services;
  2. Whose business purpose and only substance is to invest the funds for returns for a) solely capital appreciation or b) solely a combination of capital appreciation and income; and
  3. Manages and evaluates the performance of substantially all of its investments on a fair value basis.

The application guidance would centre on ‘typically, an investment entity’s ownership is in units or has multiple classes and returns with different risks and returns. An entity whose primary business purpose is solely for income is not an investment entity.’

The IASB noted that the definition should stand on its own and that the features/characteristics would be application guidance. The IASB noted that the disclosures (to be discussed at the Thursday Board meeting) would require an entity to disclose how the entity decided that it was an investment entity which would include consideration of the features/characteristics. One of the Board members suggested when drafting, it should be clearly stated that it would be unlikely for an entity to be an investment entity if that entity did not meet any features.

The FASB noted that there was a difference in scope between the FASB and the IASB approach (i.e., FASB had a broader scope). The FASB tentatively agreed with the change in terminology from factors to characteristics/indicators. The FASB also supported Alternative 1 but noted that its tentative decision was based on a definition of the investment entity along with a description of the typical characteristics of an investment entity along with one or more examples illustrating how this would be applied in practice. The FASB emphasised that it would expect an entity to meet all the characteristics/indicators (or to explain why it didn’t meet some of the characteristics/indicators) to be able to meet the criteria to be an investment entity (i.e., taking a top down approach).

Correction list for hyphenation

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