Recent Accounting Pronouncements Impacting Investment Managers and Funds

There are a handful of recent accounting pronouncements that may impact alternative investment managers, on the investment management company side and/or fund side. Some of these, such as the new lease standard, are going to be effective shortly and may require significant time and effort to adopt. Please note that the application of the accounting pronouncements below may vary based on specific facts and circumstances, so fund managers are urged to consult with their accounting advisors accordingly.

1. Accounting Standards Codification (“ASC”) Topic 842, Leases (“ASC 842”)

If you are a private entity with calendar year-end, this will be effective on January 1, 2022.

• In response to the COVID-19 pandemic and to give relief to certain types of entities, FASB issued Accounting Standards Update (“ASU”) 2020-05 in June 2020.
  • This ASU amends the effective date of ASU 2016-02 such that for private companies, ASC 842 will be effective for fiscal years beginning after December 15, 2021, and interim periods within fiscal years beginning after December 15, 2022. In November 2021, FASB voted against a further deferral in response to a request by the Pennsylvania Institute of CPAs.
• To provide further relief to lessees who are non-public entities, FASB issued ASU 2021-09 in November 2021.
  • Under ASC 842, a non-public lessee is permitted to use a practical expedient that allows them to make an accounting election to use a risk-free rate as the discount rate. This was originally an entity-wide election.
  • This new ASU permits a risk-free rate election by class of underlying asset, rather than at the entity-wide level. It also states that if the rate implicit in the lease is readily determinable for any lease, the lessee will be required to use that rate rather than risk-free or incremental borrowing rate, regardless of whether a risk-free rate election has been made.
  • All non-public entities which have not yet adopted ASC 842 as of November 11, 2021, are required to adopt ASU 2021-09 at the same time that they adopt ASC 842.
• For lessees, the main changes from the adoption of ASC 842 are the requirements to recognize leases on the balance sheet (i.e., the removal of off-balance sheet leases) and the definition of what constitutes a lease. The income statement will be impacted as well but to a lesser extent.
• For lessors, accounting remains substantially unchanged from the previous standard.
• If the lessors granted rent concessions or lessees received rent concessions in response to the pandemic, entities may make an election to i) treat a lease concession related to COVID-19 as though it results from an enforceable right, and ii) to apply or not apply the modification guidance if certain criteria are met, thereby simplifying the accounting for concessions made and received as a result of COVID-19.
• Funds: ASC 842 is likely not to have an effect on funds.
• Investment managers: Management companies may be impacted to the extent they have leased assets that were previously accounted under the old lease standard (ASC 840) guidance for operating leases and were thus not reported on the balance sheet previously.

2. ASU 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting and ASU 2021-01, Reference Rate Reform (Topic 848): Scope

If you are a private entity with calendar year-end, ASU 2021-01 will be effective immediately and ASU 2020-04 will be effective as of March 12, 2020 through December 31, 2022.

• On March 5, 2021, the Financial Conduct Authority (“FCA”) in the U.K. announced that the publication of one-week and two-month U.S. Dollar London Interbank Offered Rate (“LIBOR”) will cease after December 31, 2021, and the publication of all other U.S. Dollar LIBOR settings will cease or be deemed unrepresentative after June 30, 2023.
• ASU 2020-04 was issued to provide optional expedients and accounting relief in Topic 848 from the effects of reference rate reform on financial reporting. The practical expedients can be applied to contract modifications and eligible hedging relationships from March 12, 2020 through December 31, 2022.
• FASB then issued ASU 2021-01 to further clarify that certain optional expedients and exceptions in ASC 848 apply to only certain derivatives that are affected by the discounting transition. The amendments in this ASU are effective immediately for all entities.
• In the U.S., many financial instruments currently tied to LIBOR will be pegged instead to the Secured Overnight Financing Rate (“SOFR”), an alternative reference rate. Other countries and markets have established their own replacement benchmarks. (Please also see What Does Reference Rate Reform Mean for Financial Reporting.)
• Funds and investment managers: They should identify any financial contracts, lease agreements and derivatives that use the LIBOR as benchmark interest rate. This can impact valuation, reporting and funding.

3. ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments and ASU 2019-04 – Codification Improvements to Topic 326, Financial Instruments – Credit Losses

If you are a private entity with calendar year-end, this will be effective on January 1, 2023.

• This introduces a new impairment model based on expected credit losses rather than incurred losses.
• ASU 2016-13’s effective date for SEC filers is for fiscal years beginning after December 15, 2019, except for smaller reporting companies, whose effective date is for fiscal years beginning after December 15, 2022. The effective date for all other entities is for fiscal years beginning after December 15, 2022.
• This ASU removes the thresholds to measure and recognize credit losses for financial instruments at amortized cost. Instead, these will be measured as the difference between amortized cost and the entity’s estimate of credit losses (i.e., amount expected to be collected over the life of the financial instrument).
• ASU 2019-04 was also issued to provide certain clarifications on the calculation of credit losses. For example, recoveries on financial assets should be included in the calculation of the estimate of credit losses, which was not specifically indicated within ASU 2016-13.
• The above will likely have no effect for those who hold financial assets accounted for at fair value through net income (as expected credit losses are already embedded in the fair value).
• Funds: Those who hold instruments carried at amortized cost, including loans receivables, will be affected.
• Investment managers: This ASU is likely not to have an effect.

4. ASU 2017-08 – Receivables – Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities and ASU 2020-08 - Codification Improvements to Subtopic 310-20, Receivables - Nonrefundable Fees and Other Costs

If you are a private entity with calendar year-end, ASU 2017-08 will be effective on January 1, 2020 and ASU 2020-08 will be effective on January 1, 2022.

• ASU 2017-08 was issued to amend the amortization period for certain purchased callable debt securities held at a premium, shortening such period to the earliest call date.
• ASU 2020-08 was issued to clarify that an entity should reevaluate whether a callable debt security is within the scope of ASC 310-20-35-33 for each reporting period.
• For public business entities, the amendments in ASU 2017-08 are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2019, and interim periods within fiscal years beginning after December 15, 2020.
• For public business entities, the amendments in ASU 2020-08 are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2021, and interim periods within fiscal years beginning after December 15, 2022.
• ASU 2017-08 requires entities to amortize the premium on certain purchased callable debt securities to the earliest call date regardless of how the premium is generated. Entities will no longer recognize a loss in earnings upon the debtor’s exercise of a call on a purchased callable debt security held at a premium. They may also want to consider the ASU’s potential effect on their tax reporting.
• ASU 2020-08 is intended to make the new standard easier to understand and apply, and not expected to have a significant effect.
• Funds: These ASUs may impact funds that invest in securities such as municipal bonds since these securities are commonly issued at a premium and have call features that are consistent with the scope of the ASU.
• Investment managers: These ASUs will likely not have an effect if the management companies do not invest in securities or financial instruments directly.

5. ASU 2019-12 – Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes

If you are a private entity with calendar year-end, this will be effective on January 1, 2022.

• This ASU was issued in December 2019 to modify ASC 740 so as to simplify the accounting for income taxes.
• For public business entities, the amendments in this ASU are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2021, and interim periods within fiscal years beginning after December 15, 2022.
• This affects various aspects of ASC 740, including the accounting for taxes under hybrid tax regimes, the accounting for increases in goodwill, the allocation of tax amounts to separate company financial statements within a group that files a consolidated tax return, intraperiod tax allocation, interim-period accounting, and the accounting for ownership changes in investments, among other minor codification improvements.
• Funds and investment managers: This ASU may have an impact if they are subject to tax.