ASC 946 addresses the unique accounting and reporting requirements for investment companies under U.S. GAAP. Given the uniqueness of the industry, GAAP Dynamics offers both a fundamentals course, as well as an annual update course specifically geared to investment companies and the investment management industry. In addition to covering the latest U.S. GAAP developments impacting this industry, we also focus on application and practice issues given the unique transactions and reporting issues for financial statements of investment funds. In fact, in years when there is very limited new guidance impacting the funds, a large portion of our course is geared towards these practice issues. Our inspiration for these issues are questions and requests from our clients, as well as topics discussed by the AICPA Investment Company Expert Panel (who publish issues discussed in their meeting minutes).
These practice issues can prove useful when navigating the application of U.S. GAAP for an investment company. In fact, we’ve heard from one of our clients that he keeps binders of our update courses from past years to use as a reference when accounting issues pop up during the year.
Let’s take a quick look at one of the issues we covered in our 2022 Update course related to the accounting for perpetual bonds by an investment company. Consider the scenario below:
This scenario was inspired by a recent AICPA Investment Company Expert Panel discussion.
As you may already know, investment companies are required to account for all their investments held at fair value, with changes in fair value recognized through profit or loss (FVTPL). However, in the case of an investment in a bond, earnings consist of two components: interest income and other changes in fair value (i.e., mark-to-market). Unlike IFRS which allows an entity that measures its financial instrument at FVTPL to recognize all changes in fair value in one line item, U.S. GAAP requires that interest income be recognized separately from other changes in fair value. In fact, ASC 946 specifically requires investment income (e.g., interest income) to be presented in a separate section of the statement of operations from unrealized (and realized) gains and losses. Additionally, it is clear that interest income must be recognized using the effective interest method. This takes us to the issue at hand in our scenario.
In the scenario, Lager Fund acquired the bond at a discount and this discount must be amortized into interest income (using the effective interest method) over the life of the instrument. Of course, the issue at hand is that a perpetual bond doesn’t have an explicit term and therefore, it is not clear over how many years the discount should be amortized.
The Expert Panel discussed the issue and determined that the best practice would be to amortize the discount over a 5-year period up until the first available call date. Their rationale for this conclusion is by applying the guidance in ASC 310-20-23-33, which addresses amortization of premiums on purchased callable debt securities, by “analogy”. In this situation, the instrument has a discount, not a premium, and although the rationale for the guidance is different, the conclusion reached is useful in addressing the amortization of a discount or premium when a call feature exists. In essence, once the discount is amortized over the initial five years, interest income recognized over any future periods would simply be based on the stated interest from the bond.
But what if the instrument was NOT callable? In such instances, there would be no explicit date in which the instrument could be redeemed and the Expert Panel suggested that interest income only be recognized based on the stated interest rate of the instrument and the discount would not be amortized. In other words, the discount would simply be “amortized” through the mark-to-market of the bond through the recognition of other changes in fair value.
This example is a good illustration of how investment companies are sometimes faced with accounting and reporting challenges that are always explicitly addressed in ASC 946 or U.S. GAAP. In such cases, judgment must be applied to develop an accounting policy that is consistent with the core principles of U.S. GAAP.
Over the years, we’ve developed hundreds of these scenario-based examples highlighting the challenges of accounting and reporting by investment companies. Hearing the inspirational story from our client that has referred back to these issues as a job aide inspired us to go back to some of our favorite issues and develop a series of CPE-eligible micro-learnings (10-15 minute eLearning courses focused solely on one interesting practice issue). We will be rolling them out in the coming months.
In the meantime, if there are any specific issues you would like to see or want us to develop for you, please don’t hesitate to let us know!
About GAAP Dynamics
We’re a DIFFERENT type of accounting training firm. We don’t think of training as a “tick the box” exercise, but rather an opportunity to empower your people to help them make the right decisions at the right time. Whether it’s U.S. GAAP training, IFRS training, or audit training, we’ve helped thousands of professionals since 2001. Our clients include some of the largest accounting firms and companies in the world. As lifelong learners, we believe training is important. As CPAs, we believe great training is vital to doing your job well and maintaining the public trust. We want to help you understand complex accounting matters and we believe you deserve the best training in the world, regardless of whether you work for a large, multinational company or a small, regional accounting firm. We passionately create high-quality training that we would want to take. This means it is accurate, relevant, engaging, visually appealing, and fun. That’s our brand promise. Want to learn more about how GAAP Dynamics can help you? Let’s talk!
This post is published to spread the love of GAAP and provided for informational purposes only. Although we are CPAs and have made every effort to ensure the factual accuracy of the post as of the date it was published, we are not responsible for your ultimate compliance with accounting or auditing standards and you agree not to hold us responsible for such. In addition, we take no responsibility for updating old posts, but may do so from time to time.
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