Investment Companies ASC Topic 946: consolidation considerations

As per ASC Topic 810, ?legal entities other than limited partnerships, consolidation is appropriate if a reporting entity has a controlling financial interest in another entity and a specific scope exception does not apply. The usual condition for a controlling financial interest is ownership of a majority voting interest, and, therefore, as a general rule ownership by one reporting entity, directly or indirectly, of more than 50 percent of the outstanding voting shares of another entity is a condition pointing toward consolidation. The power to control may also exist with a lesser percentage of ownership, for example, by contract, lease, agreement with other stockholders, or by court decree.

ASC Topic 946 Investment Companies, contains special accounting requirements for investment entities. Where an entity meets the definition of an 'investment entity', it does not consolidate its subsidiaries, or apply ASC 805 Business Combinations when it obtains control of another entity. The guidance in ASC 946 notes that an exception to the general consolidation and equity method requirements occurs if the investment company has an investment in an operating entity that provides services to the investment company (for example, an investment adviser or transfer agent and the purpose of the investment is to provide services to the investment company, rather than realize a gain on the sale of the investment. If an individual investment company holds a controlling financial interest in such an operating entity, the investment company should consolidate that investee, rather than measuring that interest at fair value. If an investment company holds a non-controlling ownership interest in such an operating entity that otherwise qualifies for use of the equity method of accounting, the investment company should use the equity method of accounting for that investment, rather than measuring the investment at fair value.

ASC 946 defines 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; and measures and evaluates the performance of substantially all its investments on a fair value basis.

Fundamental characteristics of an investment company:

As per 946, ?An investment company has the following fundamental characteristic which must all been met. It is an entity that does both of the following:

• Obtains funds from one or more investors and provides the investor(s) with investment management services; and
• Commits to its investor(s) that its business purpose and only substantive activities are investing the funds solely for returns from capital appreciation, investment income, or both.
• The entity or its affiliates do not obtain or have the objective of obtaining returns or benefits from an investee or its affiliates that are not normally attributable to ownership interests or that are other than capital appreciation or investment income.

An entity that is missing even one of those fundamental characteristics is NOT an investment company. Even if an entity has all the fundamental characteristics, further analysis is still required. Typical” characteristics of an investment company are also considered. If an entity has all the typical characteristics, as defined by the FASB, then the entity is an investment company. In short, all the fundamental characteristics, plus all of the typical characteristics, means the entity is an investment company. If all of the typical characteristics are not present, then judgment must be applied to determine whether or not the entity is an investment company. ?In addition to the definition of an investment company in U.S. GAAP, the following topics are also discussed: an investment company also has the following typical characteristics:

The typical characteristics of an investment company:

• It has more than one investment;
• It has more than one investor;
• It has investors that are not related parties of the parent (if there is a parent) or the investment manager;
• It has ownership interests in the form of equity or partnership interests; and
• It manages substantially all of its investments on a fair value basis.

To be an investment company, an entity shall possess the fundamental characteristics explained above. Typically, an investment company also has all of the characteristics. However, the absence of one or more of those typical characteristics does not necessarily preclude an entity from being an investment company. If an entity does not possess one or more of the typical characteristics, it shall apply judgment and determine, considering all facts and circumstances, how its activities continue to be consistent (or are not consistent) with those of an investment company.

Measurement

Topic 946 further contains specialized accounting and reporting requirements for investment companies. Under U.S. generally accepted accounting principles (GAAP), investment companies generally measure their investments at fair value, including controlling financial interests in investees that are not investment companies. The FASB permits, but does not require, the use of NAV per share as a practical expedient for fair value if certain conditions are met. Entities may use NA V per share to estimate the fair value of investments if:

• The investment does not have a readily determinable fair value;
• The investment is in an investment company within the scope of ASC 946 Financial Services - Investment Companies, or is an investment in a real estate fund for which it is industry practice to measure investment assets at fair value on a recurring basis and to issue financial statements that are consistent with the measurement principles in ASC 946; and
• The NAV per share is calculated consistent with the measurement principles of ASC 946 as of the measurement date.