In brief: IASB finalizes definition of an "investment entity" (No. 2012-49)

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On October 31, 2012, the IASB issued amendments to existing guidance to define an "investment entity." The purpose of the amendments is to provide an exception for such entities from the existing IFRS requirement to consolidate certain subsidiaries. Investment entities will instead report all investments at fair value through profit or loss. The amendments also introduce new disclosure requirements for an investment entity's unconsolidated interest in a subsidiary. This In brief article provides an overview of the IASB's amendments. It also includes a summary of significant differences between the IASB's final IFRS guidance and the FASB’s tentative decisions to date in its US GAAP project on investment entities.

What's new?

On October 31, 2012, the IASB issued amendments to existing guidance to define an “investment entity.” The purpose of the amendments is to provide an exception for such entities from the existing requirement to consolidate certain subsidiaries. Investment entities will instead report all investments at fair value through profit or loss. The amendments also introduce new disclosure requirements for an investment entity's unconsolidated interest in a subsidiary.

What are the key provisions? 

Definition of an investment entity

The IASB originally proposed a set of prescribed criteria to qualify as an investment entity, but ultimately decided to provide a principles-based definition. An investment entity is an entity that:

• Obtains funds from one or more investors for the purpose of providing those investor(s) with investment management services
• Commits to its investor(s) that its business purpose is to invest funds solely for returns from capital appreciation, investment income, or both
• Measures and evaluates the performance of substantially all of its investments on a fair value basis

In addition, entities are required to consider whether they have the typical characteristics of an investment entity, such as multiple investments and investors, non-related party investors, and ownership in the form of equity or similar interests. While these additional characteristics are not determinative to the conclusion, an investment entity that lacks these typical characteristics is required to disclose the reasons it concluded it is nevertheless an investment entity.

Consolidation

Investment entities will account for their portfolio investments at fair value, even where they have a significant influence or a controlling financial interest in the investee. However, the final amendments do not allow such exception to consolidation for a non-investment entity parent with a controlling interest in an investment company. Rather, a non-investment entity parent of an investment entity must consolidate all entities it controls, including those controlled through an investment entity.

Is convergence achieved?

Both the IASB and FASB have agreed on a principles-based approach to defining investment entities, but there remain significant differences between the final IFRS guidance and the FASB’s tentative decisions to date. The differences largely stem from the IASB's view that the investment entity guidance is a narrow exception to consolidation. Key differences include:

• The FASB has reaffirmed its earlier decision that entities regulated under the SEC's Investment Company Act of 1940 will continue to qualify as investment companies irrespective of whether they meet the investment company definition. The IASB did not reference existing regulatory guidance given concerns that there could be different conclusions across jurisdictions, and the possibility that regulations could change.
• The IASB concluded that an entity is not an investment entity if it has more than an insignificant amount of investments that are not measured and evaluated on a fair value basis. The FASB’s definition does not have the same requirement, although it is a factor to consider in the assessment.
• The FASB tentatively decided that a parent entity will retain the specialized accounting used by an investment company subsidiary in consolidation, consistent with current US GAAP. The IASB’s guidance requires a non-investment entity parent to consolidate all controlled investees, including those that are held through an investment entity subsidiary.
• The IASB’s guidance requires investment entities to carry all of their investments at fair value, including investee funds. Current US GAAP permits, but does not require, consolidation of controlled investee funds by an investment company parent. The FASB has tentatively decided to leave this guidance unchanged.

What's the effective date?

The IASB’s amendments are effective January 1, 2014, with early adoption permitted. Entities are required to apply the amendments retrospectively, subject to certain transition reliefs.

What's next?

The FASB plans to continue redeliberations of its investment entity project over the next few months. Future topics for discussion include “fund of fund” disclosures for significant investments, changes to the current scope exception for REITs, transition guidance, and effective date. We expect the FASB to issue a final standard in the first half of 2013.

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

Luke Wilson
Senior Manager
Phone: 1-973-236-7046
Email: luke.a.wilson@us.pwc.com

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