In brief: FASB and IASB agree to principles-based definition for investment companies (No. 2012-12)

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The FASB and IASB met on May 21, 2012 to redeliberate the investment company definition project for the first time. The boards considered two items: (1) whether the IASB will continue with an entity-based approach or apply an asset-based approach and (2) the approach to apply the definition and any changes that need to be made to the related criteria and implementation guidance. As anticipated, the IASB decided to continue an entity-based approach to the project. The boards also agreed to move from a series of fixed criteria to qualify as an investment company and instead are proposing a principles-based definition with additional implementation guidance. This In brief article provides an overview of these and other items discussed at the meeting.

What's new?

The FASB and IASB (the “boards”) met on May 21, 2012 to redeliberate the investment company definition project for the first time. The boards considered two items: (1) whether the IASB will continue with an entity-based approach or apply an asset-based approach and (2) the approach to apply the definition and any changes that need to be made to the related criteria and implementation guidance.

As anticipated, the IASB decided to continue an entity-based approach to the project. The boards also agreed to move from a series of fixed criteria to qualify as an investment company and instead are proposing a principles-based definition with additional implementation guidance.

What are the key decisions?

The boards considered several potential methodologies, but in the end supported an approach that establishes a principles-based definition of an investment company. However, there are some differences between the boards on the specific wording of the definition and the application of additional factors in concluding whether the entity meets the definition.

The IASB noted that their goal is to provide a narrow exception to consolidation or equity method accounting of investees where fair value reporting was ultimately viewed as the appropriate method of reporting for the entity. Consequently, the IASB will require fair value management be included in its definition of an investment company and will require that capital appreciation (and accordingly an exit strategy) be one of the drivers of investment returns.

Conversely, the FASB’s definition will not include the requirement for fair value management but instead will retain that criterion as a factor to be considered in its implementation guidance, including the consideration of how an entity transacts with its investors and how the asset-based fees are calculated. Further, the FASB will also allow both capital appreciation and/or investment income as a means of achieving returns.

The boards also considered additional factors to be provided as implementation guidance, including number of investments and investors, related party investors, and ownership interests. No final decisions were made at the meeting. The boards have asked their staff to prepare additional research, including examples that are intended to illustrate how to weigh these factors for the entities that fall into a “gray area” of the definition. Highlights of other areas of the implementation guidance that the boards elected to modify include:

Joint decisions

• Transactions between controlled entities will not be prohibited. (Nature of investment activities)
• An entity does not need to be a separate legal entity. (Reporting entity)
• The phrase “in conjunction,” which is a concept used in the implementation guidance, is not intended to mean funds must be set up simultaneously in order to apply this guidance.
• An entity may be set up as a single investor or single investment fund in conjunction with another fund for business purposes other than legal, regulatory or tax reasons, as long as both funds otherwise meet the definition of an investment company.

IASB only

• Entities will be allowed to provide investment-related services to third parties, provided it is not substantive. (Nature of investment activities)
• Day-to-day management of investees will not disqualify an entity. (Nature of investment activities)
• An entity is required to have an exit strategy for all its investments, but may perform this assessment at the portfolio level and not at the individual investment level. (Express business purpose)

Is convergence achieved?

In addition to the areas of divergence discussed above regarding scope, there remain several areas of divergence that have not yet been addressed. We expect the boards to discuss these issues at future meetings, including whether the IASB will provide an accommodation for regulated funds, how to account for controlling financial interests in other investment companies, and retention of specialized investment company accounting by a non-investment company parent.

What's the effective date?

An effective date has not yet been determined. As currently proposed, early adoption would not be allowed.

What's next?

We expect the boards to continue their redeliberations on the project over the coming months, with a goal of issuing a final standard by the end of 2012. In particular, the IASB has indicated a final standard is necessary this year given the 2013 effective date of several related standards, such as IFRS 9 and 10.

Questions?

PwC clients who have questions about this In brief should contact their engagement partner. Engagement teams that have questions should contact the Financial Instruments team in the National Professional Services Group (1-973-236-7803).

Authored by:

Annette Spicker
Partner
Phone: 1-973-236-4088
Email: annette.p.spicker@us.pwc.com

John McCardell
Senior Manager
Phone: 1-973-236-7408
Email: john.n.mccardell@us.pwc.com

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