The investment management (IM) industry includes various diversified investment vehicles such as hedge funds, venture capital, private equity, pension funds, insurance companies, endowments, and even individuals may land in this category. An important consideration that is sometimes overlooked in the IM industry is the application of liquidation basis accounting. Investment companies should analyze facts and circumstances surrounding liquidation under ASC 205-30, Liquidation Basis of Accounting.
As suggested by the blog title, this topic makes me reminisce about the 1980s cult classic, The Breakfast Club. I hope by the end of this blog that professionals in the IM industry start singing “Don’t you (Forget about ASC 205-30)!” when discussing liquidation basis matters. By the way, if you’re looking for an overview of liquidation basis of accounting under ASC 205-30, Vicky’s blog is a great place to start!
Won’t you come see about me?
The provisions in ASC 205-30 apply to all companies except investment companies registered under the Investment Company Act of 1940. Before you navigate away thinking it’s the end of the road for the IM industry, there are still many entities in scope, including:
- Hedge funds or other private equity funds without a predetermined life that are terminated by an investment manager
- Private equity funds liquidating assets in a distressed liquidation or when liquidation is imposed by an entity
- Funds registered with the SEC but not regulated by the Investment Company Act of 1940 that is liquidating
What makes these entities in scope? In addition to the entities falling outside of regulatory requirements imposed by the Investment Company Act of 1940, these entities either do not have a specific liquidation plan within their governing documents or an event occurs to either force liquidation or otherwise require assets to be liquidated at an amount other than fair value. Management should walk through the following decision tree and identify the appropriate conclusion to the highlighted questions. This decision tree helps to determine whether liquidation is imminent.
Key matters for the IM Industry to consider include:
- Has management fully considered whether the entity should follow the guidance outlined in ASC 205-30? Management may wish to document the analysis and conclusions through the use of the decision tree above.
- What were the circumstances surrounding the liquidation event? An analysis of facts and circumstances may result in additional analysis under ASC 205-30.
Will you recognize me?
Now it’s time to determine whether liquidation is imminent. If so, the entity would apply liquidation basis accounting requirements under ASC 205-30. This process requires judgment, but is based on the following principles:
- There is a remote likelihood of return from liquidation
- Either of the following apply
- A plan for liquidation is approved by those in authority with a remote likelihood of being blocked by other parties, or
- A plan for liquidation is imposed by other parties
It is important to note that nowhere in this assessment does the guidance elaborate on the time period until liquidation. So, why is this important for the IM industry? Even if the ultimate liquidation is not for several years, an entity in the IM industry could still find that applying the liquidation basis of accounting is appropriate, as long as the entity determines that liquidation is imminent!
If an investment company determines that the liquidation basis of accounting is appropriate, then a remeasurement process would occur as of the date the liquidation event is imminent and continue until liquidation is complete. Vicky’s blog includes requirements under the liquidation basis of accounting, but here are some matters of note for the IM industry:
- Assets should be measured at the amount the entity expects to receive when it settles or disposes of the asset, even if the transaction is not orderly
- Liabilities should be adjusted to reflect changes in assumptions that are the result of the entity’s decision to liquidate (e.g., timing of payments)
- Income may include what an entity expects to earn through the end of liquidation and is recognized immediately (and updated prospectively as assumptions change)
- Expenses should include (1) estimated costs to dispose of assets and (2) any costs expected to be incurred through the end of liquidation and are recognized immediately (and updated prospectively as assumptions change)
Income and expenses can only be recognized if reasonably estimable. This threshold can usually be achieved by estimating amounts governed by existing contracts where delivery or fulfillment of the contract is probable.
Key matters for the IM Industry to consider include:
- Is the approval for liquidation documented? An investment company typically approves a liquidation plan through a board resolution.
- What are the assumptions used to value the assets under management? Liquidation basis accounting may not always result in orderly transactions.
- Are the accrued expenses reasonably estimable? The recognition threshold can get tricky in ASC 205-30 and usually requires contracts or obligations that are in force at the time liquidation is imminent.
Will you call my name?
ASC 205-30 includes limited guidance on reporting requirements for entities in scope that must follow the liquidation basis of accounting provisions. However, the standard does state that an entity should present disclosures otherwise required by other topics that are relevant to the understanding of the entity’s liquidation basis financial statements. Also of note, the AICPA Investment Companies – Audit and Accounting Guide includes AICPA Technical Questions and Answers on how to apply the liquidation basis of accounting.
In addition to the statement of assets and changes in net assets, ASC 946, Financial Services – Investment Companies, requires the disclosure of certain financial highlights, including:
- Total return or internal rate of return (IRR)
- Net investment income or expense ratios
The nature of liquidation basis of accounting may result in the distortion of certain disclosures based on the acceleration of recognition required under ASC 205-30. Judgment will be required to determine the appropriate accounting policy for investment companies related to disclosures under liquidation basis. Investment companies following the liquidation basis of accounting should consider this as well as other factors when determining the relevance and extent of information provided to users of financial statements.
Learn more about the IM Industry with GAAP Dynamics
Are you interested in learning more about the IM Industry or need a refresher on key matters for these entities? Well, GAAP Dynamics has you covered! We offer our Investment Management Industry Fundamentals (IMIF) learning path, which includes:
- Industry Overview
- Fair Value (Overview of ASC 820, Advanced Issues)
- Transactions with Service Providers
- Transactions with Unit Holders
- Financial Reporting
Only need a refresher on one of the above topics? Each of these courses is also available as an individual self-study course!
Are you looking for an update course? We also have self-study courses available for the investment companies (both U.S. GAAP and IFRS) to help you understand the latest accounting and reporting developments in the IM industry.
About GAAP Dynamics
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