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Liquidation basis of accounting is required on financial statements if an investment company separates financial statements for the liquidation period

A Brief Summary of the Recent AICPA Technical Questions and Answers Applicable to Investment Companies

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In October 2016, the AICPA issued technical questions and answers (“TQA”) to 7 practice matters related to liquidation basis of accounting and one on the effects of loan origination activity in determining investment company status of an entity. The full TQA can be accessed by clicking the titles below.

TIS SECTION 6910.36:
"Determining whether loan organization is a substantive activity when assessing whether an entity is an investment company"

This TQA discusses the considerations of an entity in determining whether loan origination activity represents a substantive business activity that precludes it from qualifying as an investment company under ASC 946-10-15-6. An evaluation of loan origination activities should include a quantitative and qualitative assessment of the significance of those activities relative to the entity’s investing activities.  Fee income generated as part of loan origination activities relative to total income is an important factor to be considered.  Other qualitative factors to consider include investing activities, regulatory considerations, entity ownership and management, customization of loans, and loan retention by the entity.

TIS SECTION 6910.37:
"Considering the length of time it will take an investment company to liquidate its assets and satisfy its liabilities when determining if liquidation is imminent."

This TQA discusses if an entity should consider the length of time it will take to liquidate its assets and satisfy its liabilities when determining if liquidation is imminent.

Under ASC 205-30-25-2, liquidation is imminent if either of the following is present:

  • A plan of liquidation is approved by an authorized person and the likelihood is remote that the plan will be blocked or that the entity will return from liquidation.
  • A plan for liquidation is imposed by other forces and the likelihood is remote that the entity will return from liquidation.

The TQA concludes that liquidation is imminent based on the occurrence of events and does not include a time element and therefore the length of time should not be taken into account when determining if liquidation is imminent.

TIS SECTION 6910.38:
"Determining if liquidation is imminent when the only investor in an investment company redeems its interest, and the investment company anticipates selling all of its investments and settling all of its assets and liabilities."

This TQA discusses whether liquidation is considered imminent in a situation where there is a single investor in an investment company and that investor redeems its interest which results in the investment company anticipating selling all investments and settling all assets and liabilities.

The TQA concludes that it depends on the intent of the investment advisor.  If the investment advisor anticipates continuing to operate the investment company using the same or similar strategy, and the lack of investors is anticipated to be temporary, the liquidation basis of accounting may not be appropriate.  If management does not intend to continue to solicit new investors or with the same investment strategy, the liquidation basis of accounting may be appropriate.

TIS SECTION 6910.39:
"Presentation of stub period information by investment company."

This TQA discusses if an investment company which has adopted liquidation basis should present information for the stub period (last balance sheet date to the date liquidation becomes imminent).

The TQA concludes that an investment company should consider the requirements of its regulator(s), the needs of the users of the financial statements, and the governing documents when determining the information to present. As the governing documents for many nonpublic investment companies require audited financial statements to be provided to investors, and such financial statements may be used to satisfy regulatory requirements (such as Rule 206(4)-2 under the Investment Advisers Act of 1940 (Custody Rule), regulations of the Commodity Futures Trading Commission, requirements of the Cayman Islands Monetary Authority, OCC or state regulations for bank collective funds)  if the date of adoption of liquidation basis differs from year-end, an investment company would most likely present stub period financial statements up to the adoption date of the liquidation basis.

TIS SECTION 6910.40:
"Applying the financial statement reporting requirements in FASB ASC 946-205-45-1 when an investment company presents a stub period."

This TQA addresses the financial statement presentation when both a stub period (going-concern) and a liquidation basis period are presented in one financial statement.  As an example, if an investment company with a December 31 year-end adopts liquidation basis on July 1, a full set of financial statements (including financial highlights)  should be presented as of June 30 and for the period January 1 through June 30 (excluding schedule of investments).  For the liquidation period from July 1 through December 31, only a statement of net assets in liquidation and a statement of changes in net assets in liquidation are required to be presented.  If investments are held as of December 31, the statement of net assets in liquidation should include a schedule of investments. The TQA also discuss the presentation of a cumulative-effect adjustment that would bridge the investment company’s ending equity balance under the going concern basis of accounting, with its opening equity balance under the liquidation basis of accounting.

TIS SECTION 6910.41:
"Separation of final-period financial statements between going concern and liquidation periods for certain investment companies that liquidate over a short period of time."

This TQA discusses if liquidation basis of accounting is required to be applied and if the investment company should separate financial information for the liquidation period from the going concern period when liquidation is expected to occur over a short period of time.  Regardless of the time it takes to liquidate, separation of the going concern period and liquidation period is required even if the fund can liquidate investments over a short period of time unless it is determined that the effect of adopting the liquidation basis is immaterial to the financial statements taken as a whole. If the effects of adopting liquidation basis of accounting are determined to be immaterial, the notes to the financial statements generally should include an affirmative statement to that effect.

TIS SECTION 6910.42:
"Presenting financial highlights under the liquidation basis of accounting for an investment company."

This TQA discusses if an investment company should present financial highlights after adopting the liquidation basis of accounting. In making that determination, a reporting entity should consider whether and how the accrual of costs and income and recognition of other assets that were recorded as of the adoption of the liquidation basis (for example, the cumulative-effect adjustment) would affect the financial highlights information and whether the result would be meaningful to a user of the entity’s financial statements.  A fund manager should consider whether financial highlights continue to be relevant and useful to understanding the fund’s statement of net assets in liquidation or statement of changes in net assets in liquidation. The TQA describes factors to consider in making that determination. If financial highlights are considered necessary, the fund manager should consider additional descriptions and/or disclosures other than those used in going concern financial statements.

TIS SECTION 6910.43:
"Accrued income when using the liquidation basis of accounting."

This TQA discusses if an investment company should accrue income related to estimated earnings on its investments through the end of its estimated liquidation period. The TQA concludes that an entity should accrue income that it expects to earn through the end of liquidation if there is a reasonable basis to do so for all investments.  Factors to be considered include investment-specific characteristics, general market conditions and estimated disposal date.  The investment company is required to disclose the type and amount of income accrued in the statement of net assets in liquidation and the period over which the income is expected to be collected or earned.


Asset Management Intelligence – Q1 2017

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Sheila Handler is a Financial Services Group Audit Director experienced with hedge funds, broker dealers, and mutual funds.

Ari Samuel has nearly 20 years of public accounting experience, providing technical guidance on accounting and auditing issues to our financial services group.