Similarities and differences*

Transcription

1 Investment Management & Real Estate Similarities and differences* Global Reporting Revolution June 2007 *connectedthinking

2 Contents How to use this publication 01 Summary of Similarities and Difference 02 Key differences 08 Framework 08 Financial Statements 09 Consolidated Financial Statements 18 Assets & Liabilities - Financial Instruments - Investments 22 Balance Sheet - Net Assets 32 Income Statement 34 Other Accounting and Reporting Topics 35 Contacts 40

3 01 How to use this publication This 1 publication is for those who wish to gain a broad understanding of the key similarities and differences between International Financial Reporting Standards ("") and accounting principles generally accepted in the United States of America ("") specifically applicable to investment funds. However, this publication is not applicable to investment funds registered with Securities and Exchange Commission ("SEC") since they are required to follow the specific guidance issued by the SEC. does not provide industry specific standards for investment funds, whereas under investment funds follow a set of industry specific accounting standards and practices, generally summarised in the AICPA Audit and Accounting Guide, Investment Company. The first part of this document provides a summary of the similarities and differences between and. It refers to subsequent sections of the document where key differences are highlighted and explained in more detail. In conjunction with reading this document, users may want to refer to International Financial Reporting Standards Illustrative Financial Statements Investment Funds, also published by. This publication does not intend to capture all similarities and differences between and, only the key similarities and differences specifically related to investment funds. When applying the standards, readers should also consult all the relevant accounting standards and, where applicable, their national laws and regulations. Such laws and regulations are not covered by this publication. Furthermore, this publication does not intend to cover the accounting by investment managers and general partners of investment funds. 1 '' refers to the network of member firms of International Limited, each of which is a separate and independent legal entity. This publication generally excludes new requirements of and standards and interpretations for financial years beginning on or after January 1, However, it does include the disclosures required by the two following standards, 7, Financial Instruments: Disclosure and IAS 1 Amendment - Presentation of Financial Statements: Capital Disclosures, which apply for annual periods beginning on or after January 1, 2007 and were early adopted for the purpose of this publication. We have also noted certain relevant developments, including the Statement of Financial Accounting Standards No. 157 Fair Value Measurement which shall be effective for fiscal years beginning on or after November 15, 2007, within the detailed text; however, not all recent developments or exposure drafts have been included.

4 02 Summary of Similarities and Differences Subject Framework Accounting Standards / Industry Practice Financial Statements Components of Financial Statements Page does not provide specific standards / requirements for investment funds, either registered or non-registered. All the standards in should be followed and an explicit and unreserved statement of the compliance with should be included in the notes to the financial statements. Two years' balance sheets, income statements, statements of changes in equity (if any), cash flow statements and notes (including the accounting policies). AICPA Accounting & Audit Guide, Investment Companies provides specific guidance on industry accounting standards and practices for both SEC registered and non-registered investment funds. This document will focus solely on non SECregistered investment funds. Comparative financial statements are not required for investment funds. Financial statements include a statement of assets and liabilities*, a schedule of investments (or a condensed schedule of investments, see below), a statement of operations, a statement of changes in net assets, a statement of cash flows (if required), notes to the financial statements * Or a statement of net assets with the schedule of investments included therein. Balance Sheet Does not prescribe a particular format for an investment fund. The balance sheet can be presented in current/non-current presentation or liquidity presentation. The statement of assets and liabilities is nonclassified and requires specific items to be presented. Investments are usually presented as first line because of their importance to an investment fund. 10 Schedule of Investments Not required but it is best practice to present a schedule of investments on a voluntary basis. If presented, comparative information should be included. If a schedule of investments is not presented, a meaningful analysis of investments should be provided so that the reader has an understanding of the nature of the investments, given their significance. Investments should be presented and disclosed either on the face of the statement of net assets or in a schedule of investments. At a minimum, a condensed schedule should be provided, with specific presentation and disclosure requirements. 11 Income Statement Does not prescribe a standard format, although expenses are presented in one of two formats (function or nature). Certain minimum items are presented on the face of the income statement. Specific items are required to be presented and disclosed on the face of the statement of operations. 12 Statement of Changes in Equity An investment fund (primarily a fund that issues puttable shares) might not have equity. In such case, a statement of changes in equity is not required. However, it is best practice to present a statement of changes in net assets attributable to holders of redeemable shares or interests. No exemptions. Specific items are required to be presented and disclosed on the face of the statement of changes in net assets. 14 Statement of Cash Flows - Exemptions If certain conditions are met, an investment fund may be exempted from presenting a statement of cash flows. 15

5 03 Subject Page Financial Statements (continued) Statement of Cash 15 Flows - Format and Standard Statement of Cash Flows - Definition of Cash and Cash Equivalents Consolidated Financial Statements Consolidation Model Special Purpose Entity Investments in Associates Standard headings, but limited guidance on contents. Either direct or indirect method can be used for cash flows from operating activities. encourages the use of direct method. May include cash equivalents with maturities of three months or less from the date of acquisition and may include bank overdrafts. No exceptions for investment funds. Consolidation is based on the existence of control defined as the power to govern the financial and operating policies of an entity so as to obtain benefits. Control is presumed to exist when the parent owns, directly or indirectly through subsidiaries, more than one half of an entity's voting power. Control also exists when the parent owns half or less of the voting power but has legal or contractual rights to control, or de facto control (rare circumstances). The existence of currently exercisable potential rights is also taken into consideration. When a feeder fund is not an SPE and has control over its master fund (such as through the ownership of voting shares), the master fund should be consolidated into the feeder fund. Should the feeder no longer have control, the master fund should be deconsolidated. In some circumstances, where the feeder fund is only to invest in one particular master fund, the feeder and master funds may represent an integrated entity, in which case the integrated entity could be considered the reporting entity and one set of financial statements is prepared. Special purpose entities should be consolidated when the substance of the relationship indicates control. Based on significant influence; presumed to have significant influence if 20% or greater interest. If less than 20%, other factors should be taken into considerations. Investments in associates should be accounted for under the equity method, except when the investments in associates are classified as financial instruments at fair value through profit or loss upon initial recognition (the "fair value option") and accounted for accordingly. However, to use the fair value option, requires certain conditions to be met (see "Financial Instruments - Classification" below) Similar to, but more specific guidance for items included in each category. Purchases and sales of investments are included in operating activities. The direct or indirect method can be used for cash flows from operating activities. Similar to, except bank overdrafts are excluded. Movements in bank overdrafts should be shown as financing activities. An investment fund should only consolidate its subsidiaries that are also investment funds. However, if an investment fund is a feeder fund within a "master / feeder" structure, the master fund should not be consolidated but shown using specific presentation requirements. Additionally, if an investment fund is classified as a fund of funds, it would not consolidate investee funds but show its investments using specific presentation requirements. Consolidation of operating companies is not appropriate except in the case of operating subsidiaries providing services to the investment fund. Not consolidated due to the deferral of the application of FIN 46R to investment funds. Investments in variable interest entities, if any, should be accounted for at fair value. Definition of an equity investee is similar to. Investments in associate held by an investment fund are accounted for at fair value, not under the equity method. However, certain associates that provide services to the investment fund are accounted for under the equity method

6 04 Subject Page Assets & Liabilities - Financial Instruments - Investments Financial Instruments - Initial Recognition A financial instrument should be recognised when an entity becomes a party to the contractual provisions of the instruments. Regular way purchases of financial assets can be recorded either on a trade date or settlement date basis. Securities transactions are recorded on the trade date basis. 22 Financial Instruments - Derecognition Financial Instruments - Classification Financial Instruments - Initial Measurement Financial Instruments - Subsequent Measurement A financial asset should be derecognised when the contractual rights to the cash flow from the financial asset have expired or are transferred together with substantially all the risks and rewards of the asset. Regular way sales can be recorded either on a trade date or settlement date basis. Classified as financial instruments at fair value through profit or loss (held for trading or designated upon initial recognition under the fair value option), available for sale, held to maturity, and loans and receivables. Held to maturity classification is generally not possible for open ended investment funds. The fair value option can be used in the following cases: (1) a financial instrument containing one or more embedded derivatives, (2) when it results in more relevant information because either it eliminates or significantly reduces a measurement or recognition inconsistency or (3) a group of financial instruments is managed and its performance is evaluated on a fair value basis. An investment fund typically classifies its investments as financial instruments at fair value through profit or loss. Investments are initially measured at fair value. In case of financial instruments at fair value through profit or loss, transaction costs, including the bid/offer spreads, should be expensed through profit and loss. Financial instruments at fair value through profit or loss are subsequently measured at fair value and the change in value is recognised in profit and loss. Available-for-sale investments are subsequently measured at fair value. Investments in equity instruments that do not have a quoted market price in an active market and whose fair value cannot be reliably measured, can be measured at cost (rare instances). Any change in value of available for sale securities is recognised in equity except for impairment losses and foreign exchange gains and losses for debt securities. Interest calculated using the effective interest rate method is recognised in the income statement. Securities transactions are recorded on the trade date basis. All investments are valued at fair value. There is no specific classification or guidance similar to the one contained in. Cost (consideration received or paid) typically represents the value of investments at initial recognition. Transaction costs are included in the cost of investments and flow through the statement of operations through unrealised gain/loss. Investments are valued at fair value. Unrealised gains or losses on investments are recognised in the statement of operations

7 05 Subject Page Assets & Liabilities - Financial Instruments - Investments (continued) Financial Instruments 26 - Fair Value Financial Instruments - Disclosure Finanical Instruments - Offsetting Fixed Income Securities - Discounts and Premiums Long positions should be valued at the bid price and short positions should be valued at the asking price. Assets and liabilities with offsetting market risks may be valued at mid-market prices for the offsetting risk positions and at bid or asking price for net position as appropriate. "Blockage factor", which is the premium or discount based on the relative size of positions (such as a large proportion of the total trading units of an instrument), is precluded for instruments quoted in an active market. For those instruments the fair value of the portfolio is the product of the number of units and the quoted bid/asking price. If the market for a financial instrument is not active, an entity establishes fair value by using a valuation technique. The chosen valuation technique shall make maximum use of market inputs and rely as little as possible on entity-specific inputs. With the adoption of 7, Financial Instruments: Disclosure, disclosures should be made through the eyes of management to enhance users' understanding of the risk exposure and the entity's risk management. As such, the disclosure requirement is extensive. 7 includes general disclosure requirements, which are not specifically designed for investment funds. Fair value of financial instruments should be disclosed. The use of judgment and key assumptions and other key sources of estimation uncertainty should be disclosed along with the nature of and the carrying amount of the affected assets and liabilities. Offsetting is allowed only when there is a legally enforceable right to set off and there is intention to settle on a net basis or to realise the asset and settle the liability simultaneously. There is no exception to the offsetting rules for master netting arrangements; all the conditions for offset must be met. Interest income and expense should be recognised using effective interest method. However this does not apply to instruments carried at fair value though profit or loss since there is no obligation to disclose interest income / expense on the face of the income statement. Can be valued at bid or asking price, last price, mean between bid and asking price, or a valuation within the range of bid and asking price. Neither use of asking price to value long positions nor use of bid price to value short positions is allowed. "Blockage factor" on unrestricted investments traded on an active market is not usually allowed. In the absence of an active market, the amounts representing estimates of fair values using methods applied consistently and determined in good faith by the board of directors should be used. Specific disclosure requirements for investment funds. Fair value of financial instruments should be disclosed. Similar to, the use of judgment, key assumptions and sources of estimation of uncertainty should be disclosed. Similar to, except that the fair value recognised for derivative contracts under a master netting arrangement can be assumed to meet the intention requirement and can be offset if other requirements are met. Premiums and discounts should be amortised using the effective interest method

8 06 Subject Balance Sheet Net Assets - Classification 1 Net Assets - Measurement Income Statement Interest and Dividend Income Recognition Realised and Unrealised Gains (Losses) on Investments - Presentation Net Gains (Losses) on Foreign Exchange - Presentation Page In a typical open end investment fund, its shares or interests are redeemable at the option of the holders of such shares or interests. The shares or interests should be classified as a financial liability regardless of their legal form. As a financial liability, their related distributions and dividends to holders of redeemable shares should be recognised as expenses in profit and loss. Net assets represent the residual value of the assets (net of liabilities). For puttable instruments, the liability is remeasured at the amount payable at the balance sheet date if the holder exercised his right to put the instrument back. Interest is recognised on an accrual basis and using the effective interest method. Dividends are recognised when the right to receive payment is established. There is no requirement to disclose net realised gains (losses) and net change in unrealised appreciation (depreciation) separately. There is no requirement to disclose net gains (losses) on foreign exchange separately. Other Accounting and Reporting Topics Functional Currency The functional currency is the currency of the primary economic environment in which an investment fund operates. The determination of the functional currency is based on a hierarchy of indicators. For an investment fund, the indicators are generally mixed and management is required to use judgment to determine the functional currency. When the presentation currency is different from the functional currency, disclosure of the functional currency and the presentation currency is required. The reason for having a different presentation currency should also be disclosed. Classified as equity. However, the shares or interests that are redeemable on a fixed date and fixed amount (or determined by reference to an interest rate index, currency index or another external index) should be classified as a liability. Distributions and dividends are recognised as transactions in equity, not in profit and loss, if the shares or interest are classified as equity. Net assets represent the residual value of the assets, net of liabilities. Similar to. 34 Net realised gains (losses) and net change in unrealised appreciation (depreciation) should be disclosed separately. Distinction should be made between realised and unrealised gains or losses on foreign exchange. The foreign currency element of gains or losses on investments may be presented separately or together with the local currency market gains or losses on investments. Definition of functional currency is similar to. The determination is similar to except that US GAAP has no hierarchy On June 22, 2006, the IASB issued an exposure draft to amend IAS 32. Under the exposure draft, the definition of a financial liability will be amended. Please see the discussion in "Net Assets - Classification".

9 07 Subject Page Other Accounting and Reporting Topics (continued) Foreign Currency Transactions Foreign currency transactions are initially recorded using the exchange rate at the date of the transactions. Subsequently at each balance sheet date, foreign currency monetary items and balances shall be translated using the closing rate and non-monetary items shall be translated using the historical exchange rates. Non-monetary items that are measured at fair value in a foreign currency shall be translated using the exchange rates at the date when the fair value was determined. Similar to. 36 Foreign Currency Translation NAV per Share Earnings per Share When translating the financial statements of an entity from the functional currency into the presentation currency assets and liabilities shall be translated at the closing rate and income statement items shall be translated at exchange rates at the dates of the transactions. The resulting exchange differences shall be recognised as a separate component of equity. Not required but it is common practice to disclose NAV per share. Earnings per share information is not required when the equity instruments of an investment fund are not publicly traded. Also if all the shares of an investment fund are classified as financial liabilities, there is no requirement to disclose the earnings per share information. Similar to. 36 Required. 37 Not required. 37 Financial Highlights Not required. Required and should follow specific calculation, disclosure and presentation requirements. Related Party Transactions Segment Reporting Amounts and nature of transactions, and balances due to / from related parties should be disclosed. Required unless an investment fund's shares or debt instruments are not publicly traded. Similar to. 38 Not required

10 08 Key differences Framework For the overall comparison of and, please see our publication "Similarities and Differences - A Comparison of and ". The following is only a comparison of areas specifically related to non-sec registered investment funds. Accounting Standards / Industry Practice, as a set of principle-based accounting standards, does not provide accounting standards or guidance specific to the investment fund industry. As such, investment funds follow the same financial reporting standards, which are developed for general enterprises. The objective of general purpose financial statements is to provide information about the financial position, financial performance and cash flows of an entity so that users can make informed economic decisions. Financial statements also show the results of management's stewardship of the resources entrusted to it (IAS 1). includes International Financial Reporting Standards, International Accounting Standards and interpretation originated by IFRIC or former SIC (IAS 1.11). Investment funds are required to follow all such standards in order to be in compliance with and an explicit and unreserved statement of such compliance should also be made in the notes to the financial statements (IAS 1.14). provides industry specific accounting standards and guidance, in addition to the general authoritative accounting pronouncements. AICPA Audit and Accounting Guide, Investment Companies ("AAG-Inv") details the investment fund industry specific guidance and standards. The overall objective of financial statements, including financial highlights, of investment funds is to present net assets, results of operations, changes in net assets, and financial highlights resulting from investment activities and, if applicable, from capital transactions (AAG-Inv 7.01).

11 09 Financial Statements Components of Financial Statements The financial statements are comparative (IAS 1.36) and include (IAS 1.8): 1) A balance sheet; 2) An income statement; 3) A statement of changes in equity; 4) A cash flow statement; and 5) Notes, comprising a summary of significant accounting policies and other explanatory notes. When an investment fund has voting non-participating shares in addition to the redeemable shares or when it has investments classified as available for sale securities or other balances classified under equity, the fund needs to present a statement of changes in equity. An investment fund, whose redeemable shares are classified as a financial liability and which does not have any other transaction classified under equity, is not required to present a statement of changes in equity since it does not have equity. Alternatively, it is best practice to present a statement of changes in net assets attributable to holders of the redeemable shares. The date of authorisation to issue financial statements, and who authorises them for issue, should be disclosed. For a non-registered investment fund, comparative financial statements are not required. AAG-Inv specifies the requirements for financial statements, which should include: 1) A statement of assets and liabilities with a schedule of investments or a statement of net assets, which includes a schedule of investments therein as of the close of the latest period. At a minimum a condensed schedule of investments should be provided for each statement of assets and liabilities. (balance sheet); 2) A statement of operations (income statement); 3) A statement of changes in net assets; 4) A statement of cash flows (see below for exemptions); 5) Notes to the financial statements, including the summary of accounting policies; and 6) Financial highlights, either presented as a separate schedule or disclosed in the notes to the financial statements. The disclosure of the authorisation of financial statements for issue similar to is not required, unless required by local laws and regulations.

12 10 Balance Sheet does not prescribe a specific format. At a minimum, the face of balance sheet should include (IAS 1.68): 1) Investment property; 2) Financial assets; 3) Investments accounted for using the equity method; 4) Trade and other receivables; 5) Cash and cash equivalents; 6) Trade and other payables; 7) Financial liabilities; 8) Tax assets and liabilities; 9) Provisions; 10) Minority interest; and 11) Issued capital and other components of shareholders' equity. (The above are the items applicable to a typical investment fund. Please see paragraph 68 of IAS 1, Presentation of Financial Statements for the complete list.) An investment fund can present additional line items, headings and subtotals on the face of the balance sheet when such presentation is relevant to an understanding of its financial position (IAS 1.69). An entity should present current and non-current assets, and current and non-current liabilities on the face of balance sheet except when a presentation based on a liquidity, in which assets and liabilities are presented in the order of liquidity, provides information that is reliable and more relevant. Due to the nature of an investment fund, where typically all or substantially all of its assets and liabilities are current, the liquidity presentation may be more relevant and is generally followed in practice (IAS 1.51). However, management should assess which format will provide more relevant and reliable information to the users of the financial statements. If the liquidity presentation is selected, assets and liabilities with maturities greater than 12 months should be identified in the notes. For a typical investment fund whose shares are redeemable at the option of its holders, it might not have shareholders' equity at all or only a nominal amount representing its voting, non-participating shares (please see "Net Assets - Classification" for detailed discussion). Although there is no specific format, IE 32 and IE 33 of IAS 32, Financial Instruments: Disclosure and Presentation provide examples of balance sheets for entities with no equity or some equity. However, IE 31 and IE 33 specifically state that other formats are possible. International Financial Reporting Standards Illustrative Financial Statements Investment Funds also provides an example for reference.

13 11 For an investment fund, a balance sheet is called a statement of assets and liabilities when there is a separate schedule of investments, or a statement of net assets which includes a schedule of investments therein (AAG-Inv 7.01). The format of the balance sheet is well developed and most investment funds follow the format of the illustrative financial statements in the AAG-Inv (7.87). AAG-Inv specifies the major categories of assets and liabilities to be reported on the face of the balance sheet (AAG-Inv 7.20 to 7.36): 1) Investment in securities; 2) Cash; 3) Receivables; 4) Other assets; 5) Accounts payable; 6) Call or put options written, futures contracts sold, and securities sold short; 7) Accrued liabilities; 8) Notes payable and other debt; 9) Other liabilities; and 10) Net Assets. As in, additional line items can be presented. Under, the balance sheet is non-classified since all assets and liabilities of an investment fund are presumed to be current. Furthermore, the general practice of the industry is to present investments as the first asset because of their relative importance to total assets (AAG-Inv 7.21). Schedule of Investments A schedule of investments or a condensed schedule of investments is not required under. However it is best practice to include such schedule. Illustrative Financial Statements Investment Funds also provides an example for reference. Since the financial statements are comparative, the schedule of investments or condensed schedule of investments, if presented, should be comparative as well. If a schedule of investments is not presented, a meaningful analysis of investments should be provided so that the reader has an understanding of the nature of the investments, given their significance.

14 12 At a minimum, a condensed schedule of investments is required (AAG-Inv 7.01). An investment fund may alternatively present a full schedule of investments, which details all its individual positions and investments. The format and minimum disclosure requirements of the condensed schedule of investments and the schedule of investments are specified in AAG-Inv. Investments should be categorised by the following (AAG-Inv 7.16): 1) Type; 2) Country or geographic region; and 3) Industry. For investment funds classified as "investment partnerships", the name, share or principal amount, value and type should be disclosed for each investment constituting more than 5% of net assets and for investments from the same issuer if their aggregate is more than 5% of net assets. For derivatives whose fair value exceeds 5% of net assets, the range of expiration dates and fair value of a particular underlying asset should be disclosed. For investment in another investment fund whose fair value exceeds 5% of net assets, the investment objective and restrictions on redemptions should be disclosed (AAG-Inv 7.16). For private investment funds that are not "investment partnerships", the above criteria are measured at the 1% level rather than the 5% level, and at least the 50 largest investments must be identified even if certain investments do not exceed 1% of net assets (AAG-Inv 7.14). Furthermore, for investments in other investment funds, if the reporting fund's proportionate share of any security owned by an investee investment fund exceeds 5% of the reporting fund's net assets, such security should be disclosed (the "look-through" provision) (AAG-Inv 7.17). Detailed specific disclosure and presentation requirements and guidance can be found in AAG-Inv, Statement of Position ("SOP") No. 95-2, Financial Reporting by Nonpublic Investment Partnerships, and SOP 03-4, Reporting Financial Highlights and Schedule of Investments by Nonpublic Investment Partnerships. If comparative financial statements are presented, a schedule of investments for each period should be presented (AAG-Inv 7.01). Income Statement does not prescribe a specific format. IE 32 and IE 33 of IAS 32 provide examples of income statements for entities with no equity or some equity. Illustrative Financial Statements Investment Funds also provides an example for reference. Expenses should be classified according to nature or function (IAS 1.88). If the classification by function is used, additional information on the nature of expenses should be disclosed.

15 13 Income received net of withholding taxes should be included gross in the income statement. The withholding taxes should be presented as a separate component of income tax for the period. The portion of the profit and loss attributable to the minority interest is disclosed separately in the income statement (IAS 1.82). An investment fund can present additional line items, headings and subtotals on the face of the income statement when such presentation is relevant to an understanding of its financial performance (IAS 1.83). The minority portion of net income is presented after the "net income" line as an allocation of "net income". An income statement is usually called a statement of operations. The objective of the statement of operations is to present the increase or decrease in net assets resulting from all of a fund's investment activities. As such, format and disclosure requirements are specified and included in AAG-Inv as follows: 1) Investment income; a. Dividend income; b. Interest income; c. Other income; 2) Expenses; a. Investment advisory fees; b. Administration fees; c. Shareholder service costs; d. Distribution expenses; e. Custodian fees; f. Federal and state income taxes; g. Other taxes; h. Interest; i. Dividends on securities sold short; j. Professional fees; k Directors' or trustees' fees; l. Registration fees and expenses; 3) Net investment income (total of No. 1 and 2 above); 4) Net realised gain or loss from investments and net realised gains or losses from foreign currency transactions (please see "Gain on Foreign Exchange" below for further discussion); 5) Net increase (decrease) in unrealised appreciation or depreciation on investments and net unrealised gains (losses) on foreign exchange (please see "Gain on Foreign Exchange" below for further discussion); 6) Net realised and unrealised gain or loss from investments and foreign currency (total of No. 4 and 5 above); and 7) Net increase or decrease in net assets / partners' capital from operations (net income).

16 14 Other common and major specific format / presentation requirements under AAG-Inv and applicable to non-registered investment funds are: 1) Withholding taxes - Withholding taxes should be deducted from the relevant income item (e.g., dividends) and disclosed parenthetically or shown as a separate contra item in the income section (AAG-Inv 7.43); 2) Incentive allocation - If organised as a limited partnership, an investment fund's incentive allocation (e.g., an allocation from limited partners to the general partner) should be presented in the statement of changes in partners' capital, rather than as an expense item in the statement of operations (AAG-Inv 7.49); and 3) Fees and expenses waived or reimbursed - Fees and expenses waived and reimbursed, both voluntarily and involuntarily, should be disclosed on the face of the income statement as a reduction of total expenses (AAG-Inv 7.45). If there is minority interest, unlike, the minority interest portion is a deduction to calculate the net increase or decrease in net assets / partners' capital from operations. Statement of Changes in Equity does not prescribe a specific format. The general presentation and disclosure requirements are detailed in IAS 1.96 and For an investment fund with no equity (i.e., all the shares are classified as a liability under IAS 32 and the fund does not have any other equity reserves), the statement of changes in equity is not required. However, investment funds generally present a statement of changes in net assets attributable to holders of redeemable shares since it provides relevant and useful information to the reader corresponding to the requirements of IAS 1 and is considered to be best practice. Illustrative Financial Statements Investment Funds also provides an example for reference. A statement of changes in net assets summarises results from operations, net equalisation credits or debits, dividends or distributions to shareholders, capital share transactions, and capital contributions (AAG-Inv 7.62). In addition to beginning and ending net assets, AAG-Inv specifies the items to present as the increase and decrease in net assets (AAG-Inv 7.63): 1) Net change in net assets resulting from operations - Net investment income or loss, net realised gains or losses from investments and foreign currency transactions, and changes in unrealised appreciation or depreciation on investments and foreign exchange, as shown in the statement of operations, should be presented separately to arrive at the net change in net assets resulting from operations;

17 15 2) Net equalisation debits or credits; 3) Distributions to shareholders; 4) Capital share transactions (issuance, redemption and repurchase) for each class of shares / series, which can be either presented in the statement or in the notes; and 5) Capital contributions. Statement of Cash flows - Exemption does not provide exemptions for the presentation of a statement of cash flows. A statement of cash flows is required unless meeting all of the following conditions (FAS 102.7): 1) Substantially all investments are liquid; 2) Substantially all investments are carried at fair value; 3) There is little or no debt, based on average debt outstanding during the period in relation to average total assets; and 4) A statement of changes in net assets is presented. Statement of Cash flows - Format and Standard does not prescribe a specific format. A statement of cash flows should report cash flows classified by operating, investing and financing activities (IAS 7.10). The cash flows from operating activities can be presented using either the direct or indirect method (IAS 7.18) although encourages the use of the direct method (IAS 7.19). Unlike, regardless whether the direct and indirect method is used, cash flows from interest and dividends received and paid should be disclosed separately within the statement of cash flows and classified consistently as either operating, investing or financing activities (IAS 7.31). Cash flows from taxes should also be disclosed separately and classified as operating activities unless specifically identified with financing or investing activities (IAS 7.35). In accordance with IAS 7.16.c and 7.16.d, purchases and sales of investments should be considered investing activities. However, IAS 7 is not designed specifically for an investment fund. Due to the fact that an investment fund's operations consist entirely of investing in securities, the cash flows from the purchases and sales of investments are generally classified as operating activities instead.

18 16 Purchases and sales of investments can be shown separately (IAS 7.16.c and 7.16.d) on a gross basis. Alternatively, they can be shown on a net basis (IAS 7.22.b and IAS 7.24) if the turnover is quick, the amounts are large and the maturities are short. Non-cash transactions should be excluded from the statement of cash flows and should be disclosed in the notes to the financial statements (IAS 7.43). Similar to, the statement classifies cash receipts and cash payments as resulting from operating, investing, and financing activities. Similar to, the cash flows from operating activities can be presented using either the direct or indirect method. However, also requires the statement to include a reconciliation of net cash provided by and used for operating activities to net increase or decrease in net assets from operating activities (AAG-Inv 7.67). As such, the indirect method is more commonly used. Since it is more commonly used (AAG-Inv 7.68), the below discussion focuses solely on the indirect method. Purchases and sales of investments should be included in operating activities (AAG-Inv 7.68). As such, an investment fund typically does not have cash flows from investing activities in its statement of cash flows. Also, purchases and sales of investments should be presented on a gross basis, rather than on a net basis. AAG-Inv specifies the items to be included for each type of activity. 1) Operating activities (AAG-Inv 7.70), which represents the reconciliation of net cash provided or used for operating activities to net increase or decrease in net assets from operating activities; a. Purchases and sales of investments; b. Changes in non-investment asset and liability accounts; c. Non-cash income and expense items; d. Realised and unrealised gains on investments; 2) Financing activities (AAG-Inv 7.69); a. Issuance and redemption of fund shares; b. Proceeds from and repayment of debt; c. Dividends and distributions to shareholders; and d. Bank overdrafts. Information about non-cash investing and financing activities should be disclosed (AAG-Inv 7.72). If the indirect method is used, interest paid and income taxes paid should be disclosed as supplemental disclosure (FAS 95.29).

19 17 Statement of Cash flows - Definition of Cash and Cash Equivalents Cash comprises cash on hand, demand deposits and cash equivalents which are short-term, highly liquid investments that are readily convertible into known amounts of cash and which are subject to an insignificant risk of change in value (IAS 7.6). Usually, an investment qualifies as a cash equivalent when it has a maturity of three months or less from the date of acquisition (IAS 7.6). Bank overdrafts can be included as a component of cash and cash equivalents if they are repayable on demand and form an integral part of an entity's overall cash management (IAS 7.8). There is no requirement to disclose the amounts of cash and cash equivalents denominated in foreign currencies and their acquisition cost under in the statement of cash flows. However foreign currency information is generally part of the financial instrument disclosures. Cash and cash equivalents not available for use of a fund should be disclosed (IAS 7.48). Cash and cash equivalents subject to withdrawal or usage restrictions should be presented separately from other cash amounts (IAS 7.23). Similar to, cash comprises cash on hand and demand deposits (Footnote 1 of FAS 95). Also similar to, cash equivalents are defined as short-term (usually three months or less), highly liquid investments that are both readily convertible to known amounts of cash and so near maturity that they represent insignificant risk of changes in value (FAS 95.8). Unlike, the definition of cash and cash equivalents under FASB Statement ("FAS") No. 95, Cash Flow Statements, does not include bank overdrafts. Furthermore, AAG-Inv specifically requires bank overdrafts to be included in financing activities. As such, bank overdrafts should not be included as a component of cash and cash equivalents. Amounts held in foreign currencies should be disclosed separately at value, with acquisition cost shown parenthetically on the face of the balance sheet.

20 18 Consolidated Financial Statements Consolidation Model The accounting standards on consolidation are set forth in IAS 27, Consolidated and Separate Financial Statements, which does not provide a scope exception for an investment fund. An investment fund should consolidate all its investments in which it has control (IAS 27.4). Control is defined as the power to govern the financial and operating policies of an entity so as to obtain control: 1) Control is presumed to exist if a fund owns more than half of voting power of another entity; 2) If a fund owns half or less than half of voting power, control also exists if it has: a. Power over more than half of voting rights by virtue of an agreement with other investors; b. Power to govern the financial and operating policies of the entity under a statute or an agreement; c. Power to appoint or remove the majority of the members of the board of directors or equivalent governing body and control of the entity is by that board or body; or d. Power to cast the majority of votes at meetings of the board of directors or equivalent governing body and control of the entity is by that board or body. The existence of currently exercisable potential rights, such as warrants, call options or convertible instruments, should also be taken into consideration under the consolidation model. As a result of the consolidation model in IAS 27, the accounting practice can be significantly different from. An investment fund should consolidate any investments, which are deemed to be subsidiaries under IAS 27. A subsidiary is defined as an entity, including an unincorporated entity such as a partnership, that is controlled by another entity (IAS 27.4). For example, a feeder fund that is not an SPE, which has the majority of voting shares of the master fund in a "master / feeder" structure, will need to consolidate the master fund. In cases where the feeder fund only owns non-voting participating shares of a master fund, other criteria, such as whether the feeder fund has the power to govern by virtue of an agreement (such as a control agreement between the feeder fund and the master fund) or laws should be considered. In some circumstances, where a feeder fund is only to invest in one particular master fund, the feeder and master funds may represent an integrated entity.

21 19 In such case, the integrated entity could be considered the reporting entity and only one set of financial statements is prepared. Furthermore, a fund of funds or a private equity fund may need to consolidate the investments in other investment funds or investee companies, for which it has control as defined in IAS 27. Such control exists when the fund of funds or the private equity fund owns more than half of voting shares or interests in another investment fund or investee company. However if the fund of funds only holds non-voting shares and the holders of the voting shares have the ability to direct the financial and operating policies of the fund, the fund of funds should not consolidate the investee fund. A private equity fund typically purchases investments, including controlling interests, in investee companies with a view to resale. However, unless qualified as a disposal group held for sale at acquisition under the criteria in 5, Non-Current Assets Held for Sale and Discontinued Operations, such investee companies should be consolidated. The criteria include that the assets should be available for immediate sale and such sale should be highly probable, including the requirement of completion the sale within one year ( 5.7 and 5.8). An investment fund should only consolidate subsidiaries which are also investment funds (subject to industry practice, please see below for further discussion). The investment fund should not consolidate a non-investment fund investee, unless such investee is an operating company that provides services to the investment fund (AAG-Inv 7.04 and 7.05). According to industry practice, a feeder fund within a master / feeder structure will not consolidate its master fund even if it owns the majority of the master fund's voting shares. The feeder fund should either present the master fund's financial statements together with its own, or report on the investment in the master fund as indirect portfolio investments under paragraph 11 of SOP 95-2, as amended (AAG-Inv 7.07). Additionally, if an investment fund is classified as a fund of funds, it would not consolidate investee funds but show its investments using specific presentation requirements (AAG-Inv ). Given industry practice in and unlike, private equity or venture capital funds do not consolidate their investee companies even if there is control over the investee companies.

22 20 Special Purpose Entity Similar to IAS 27 discussed above, SIC-Interpretation ("SIC") No. 12, Consolidation of Special Purpose Entities, does not provide a scope exception to an investment fund. An investment fund should consolidate any special purpose entity ("SPE"), which is an entity created to accomplish a narrow and well-defined objective (SIC 12.1), when the substance of the relationship indicates that the SPE is controlled by the investment fund (SIC 12.8). To establish control, the control criteria under IAS 27 (see "Consolidation Model") should be considered. Furthermore, the following circumstances may indicate control (SIC 12): 1) In substance, the activities of the SPE are being conducted on behalf of an entity according to its business need so that the entity obtains benefits from the SPE's operations; 2) In substance, the entity has the decision-making powers to obtain the majority of the benefits of the activities of the SPE or, by setting up an autopilot mechanism, the entity has delegated these decision-making powers; 3) In substance, the entity has rights to obtain the majority of the benefits of the SPE and therefore may be exposed to risks incident to the activities of the SPE; or 4) In substance, the entity retains the majority of the residual or ownership risks related to the SPE or its assets in order to obtain benefits from its activities. As a result of the provisions under SIC 12, an investment fund should consolidate an investee entity that is qualified as an SPE. In cases where an investment fund may not have control as defined in IAS 27 over its investee entity, the provisions under SIC 12 should also be considered. SPEs are referred to as "Variable Interest Entities" ("VIE") under. FASB Interpretation ("FIN") No. 46, Consolidation of Variable Interest Entities, as revised, requires the consolidation of variable interest entities ("VIE"). Under paragraph 36 of FIN 46R, the effective date of the application of FIN 46R for investment funds has been deferred. However, this deferral does not extend to investments made after March 27, 2002, that are held by an investment fund that is not a separate entity, unless those investments were acquired pursuant to an irrevocable binding commitment that existed prior to March 28, FIN 46 also requires disclosure about any VIE that the investment fund is not required to consolidate. As a result of the deferral, investments in VIE should be accounted for at fair value under.

23 21 Under the proposed FSP FIN 46R-d, paragraph 4(e) of FIN 46R will be amended such that investments accounted for at fair value in accordance with the specialised accounting guidance in the AAG-Inv are not subject to consolidation according to the requirements of FIN 46R. If adopted, the application of FIN 46R to investment funds will be officially scoped out. Investments in Associates An associate is an entity over which an investment fund has significant influence and is neither a subsidiary nor an interest in a joint venture (IAS 28.2). An investment fund is presumed to have significant influence over an entity when it has more than 20% of the voting power of that entity. If less than 20%, other factors should be taken into consideration to determine the existence of significant influence. IAS 28.7 provides certain examples of such factors. Investments in associates should be accounted for using the equity method of accounting. However, IAS 28 provides an exception when the investments are held by an investment fund that upon initial recognition are designated as financial instruments at fair value through profit or loss (the fair value option) or are classified as held for trading (IAS 28.1). Under the exception, the investments should be accounted for at fair value. However, certain criteria should be met in order for a fund to use the fair value option (please see "Financial Instruments - Classification" below). Typically under, investments subject to significant influence should be accounted for under the equity method. The definition of significant influence is similar to and is discussed in paragraph 17 of Accounting Principles Board ("APB") Opinion No. 18, The Equity Method of Accounting for Investments in Common Stock. However, APB No. 18 does not apply to investment funds (APB No 18.2) and AAG-Inv states that the use of equity method of accounting by an investment fund of a non-investment fund investee is not appropriate (AAG-Inv 7.04). An exception is a non-investment fund which provides services to the investment fund.

24 22 Assets & Liabilities - Financial Instruments - Investments Financial Instruments - Initial Recognition Investment funds follow the general principle in the initial recognition of financial assets and financial liabilities in IAS 39, Financial Instruments: Recognition and Measurement. A financial asset or a financial liability should be recognised when, and only when, an entity becomes a party to the contractual provisions of the instrument, subject to the provisions governing regular way purchases and sales of financial assets (IAS 39.14). A regular way purchase or sale is a purchase of a financial asset under a contract whose terms require delivery of the asset within the time frame established generally by regulation or convention in the market place concerned (IAS 39.9). Examples of regular way purchases and sales include securities traded on an exchange or an over-the-counter market. Regular way purchases of financial assets should be recognised using trade date accounting or settlement date accounting (IAS 39.38). The choice of method is an accounting policy and should be disclosed. The method used should be applied consistently for purchases and sales of investments that belong to the same category (IAS 39 - AG53). The accepted practice is to record securities transactions on a trade date basis rather than on a settlement date basis (AAG-Inv 2.25). Transactions for private placements or other securities purchased and sold outside of conventional channels, such as stock exchanges, should be recorded as of the date the investment fund obtained a right to demand the securities purchased and incurred the obligation to pay the price for the securities purchased (AAG-Inv 2.26). Financial Instruments - Derecognition Regular way sales of financial assets should be recognised using trade date accounting or settlement date accounting (IAS 39.38). The choice of method is an accounting policy and should be disclosed. The method used should be applied consistently for purchases and sales of investments that belong to the same category (IAS 39 - AG53). When the sale of a financial asset is not a regular way sale, the financial asset (or part) should be derecognised, when (IAS ): 1) The right to the cash flow from the financial asset expires or is transferred; 2) The right to the financial asset's cash flows and substantially all risks and rewards of ownership are transferred;

25 23 3) An obligation to transfer the asset's cash flows is assumed, substantially all risks and rewards are transferred and the following conditions are met: a. No obligation to pay cash flows unless equivalent cash flows from the transferred asset are collected; b. Prohibition from selling or pledging the asset other than as security to the eventual recipient for the obligation to pass through cash flow; and c. Obligation to remit any cash flows without material delay; or 4) Substantially all the risks and rewards are neither transferred nor retained, but control of the asset is transferred. A financial liability should be derecognised when the obligation specified in the contract is discharged or cancelled or expired. A financial liability is also considered extinguished if there is a substantial modification in the terms of the instrument (IAS 39.39,.40). Upon derecognition, the difference between the carrying amount of the financial instruments and the consideration paid should be recognised as gain or loss in the profit and loss (IAS 39.41). Specific identification method of costing cannot be used under.(ias 2.41). For investments sold by an investment fund, the derecognition criteria are met usually on the trade date and it is also industry practice to record investment transactions on the trade date basis. The accepted practice is to record securities transactions on a trade date basis rather than on a settlement date basis (AAG-Inv 2.25). Transactions for private placements or other securities purchased and sold outside of conventional channels, such as stock exchanges, should be recorded as of the date the investment fund obtained a right to collect the proceeds of sales, and incurred the obligation to deliver the securities sold (AAG-Inv 2.26). Upon derecognition, the difference between the consideration received or paid and the cost should be recognised as realised gains or losses. The cost is determined based on either a specific identification method or average cost method (AAG-Inv 2.41). Financial Instruments - Classification Financial instruments are classified as follows: 1) Financial instruments at fair value through profit or loss; 2) Available for sale; 3) Held to maturity; and 4) Loans and receivables. Financial assets can be classified as one of the above four categories, while financial liabilities can be classified either as financial liabilities at fair value through profit or loss or at amortised cost.

26 24 Financial instruments at fair value through profit or loss are further divided into two sub-categories: financial instruments at fair value through profit or loss upon initial recognition (the fair value option, subject to the conditions below) or held for trading. Unless designated as a hedging instrument, a derivative should always be designated as held for trading. The fair value option may be used when (IAS 39.9 and.11a) 1) A contract contains one or more embedded derivatives and in such case the entire hybrid can be designated as a financial asset or financial liability at fair value through profit or loss; or 2) Such use results in more relevant information, because either: a. It reduces or significantly reduces a measurement or recognition inconsistency that would otherwise arise from measuring assets and liabilities or recognising the gains and losses on them on a different basis; or b. A group of financial assets, financial liabilities or both is managed and its performance is evaluated on a fair value basis, in accordance with documented risk management or investment strategy, and information about the group is provided internally on that basis to the entity's key management personnel. Since an investment fund typically manages its investments on a fair value basis or trades often, its investments are typically classified as financial instruments at fair value through profit or loss trading category. Investments held by a private equity fund or venture capital fund may not qualify as held for trading since the turn-over of such investments is not typically near term. In such case, the fund can designate the investments, upon initial recognition and through the use of the fair value option, as financial instruments at fair value through profit or loss (subject to the conditions on the use of the fair value option described above). Similarly for a fund of funds, if it has a low turnover of its investments or otherwise its investments are not qualified as held for trading, its investments can be classified as financial instruments at fair value through profit or loss upon initial recognition assuming the conditions for the fair value option are met. Note that the fair value option only applies to financial assets within the scope of IAS 39 or IAS 28 (significant influence). An investment that needs to be consolidated under IAS 27 or SIC 12 cannot be designated at fair value through profit or loss in the consolidated financial statements. Caution should be taken in the classification of financial instruments. Once designated, an investment fund will not be able to reclassify financial instruments into or out of at fair value through profit or loss category (IAS 39.50). In some circumstances, investments may be classified as available for sale. However, available for sale is still required to be valued at fair value unless there is no reliable fair value, in which case it is valued at cost (only in rare

27 25 circumstances, generally a fair value can be reliably determined). Even when valued at cost, available for sale instruments still need to be assessed for impairment which would require an estimate of the present value of the future cash flows (IAS 39.66). Please see "Subsequent Measurement" below for the further discussion of the result of different classification. Due to the nature of the business of an investment fund, it is industry practice and the requirement of AAG-Inv to value all investments at fair value. As such, there is no specific disclosure requirement on the classification of investments. Financial Instruments - Initial Measurement A financial asset and a financial liability should initially be measured at fair value (IAS 39.43). The fair value is typically the amount paid at the time of transaction unless there is observable market evidence that the amount paid is not fair value. Transaction costs, including the "bid-ask spread", directly attributable to the acquisition or issue of financial instruments at fair value through profit or loss should be expensed through profit and loss. On other hand, transaction costs of available-for-sale and held-to-maturity instruments should be included in the amount initially measured. (IAS 39.43) Since investments held by an investment fund are typically financial instruments at fair value through profit or loss, the investment fund should follow the requirement to expense the transaction costs, including the "bid-ask spread". There is no requirement under to disclose separately the bid-ask spread on the face of the income statement. It can be included as part of the change in fair value of the securities. Securities transactions are recorded at cost and such cost should be disclosed parenthetically on the face of the statement of assets and liabilities. Cost includes commissions or other charges related to the acquisition of investments (AAG-Inv 2.41). Financial Instruments - Subsequent Measurement The general principles for subsequent measurement: 1) Financial instruments at fair value through profit or loss should be subsequently measured at fair value without any deduction of transaction costs that may be incurred on disposal (IAS and 47.a). Change in value should be recognised as gain or loss in profit and loss (IAS 39.a); 2) Available-for-sale instruments should be subsequently measured at fair value (IAS 39.46) or at cost if their fair value cannot be reliably determined (IAS 39.46c). Change in value should be recognised directly in equity, through the statement of changes in equity (IAS 55.b), except for impairment charges and the impact of movements in foreign currency

28 26 exchange rates on amortised cost of available for sale debt instruments. Furthermore, related interest income should be recorded in profit and loss (IAS b); and 3) Others should be subsequently measured at amortised cost. For all financial instruments which are not measured at fair value through profit or loss, any impairment should be assessed and such impairment, if identified, should be recorded as gain or loss in the profit and loss. An investment fund may want to classify some of its investments as available for sale for various reasons. If it does not have equity due to the adoption of IAS 32, the change in value of available for sale should not be recognised as gain or loss in the profit and loss. A statement of changes in equity showing the movement in retained earnings (including the movements and the cumulative balance of profit and loss, excluding change in fair value resulting from available for sale securities, attributable to holders of redeemable shares) and the movements and the cumulative balance of available for sale reserve should be presented. Investments should be reported at fair value in the statement of assets and liabilities (AAG-Inv 7.22). Receivables are usually listed separately at their realisable value. Receivables include, among others, dividend and interest, investment securities sold, capital stock sold and other accounts receivables. Financial Instruments - Fair Value Investments listed in an active market should be valued at bid price for long positions and asking price for short positions. When an investment fund has financial assets and liabilities with offsetting market risks, it may use mid-market prices to determine fair value for the offsetting risk positions and apply bid or asking prices to the net open position as appropriate. Blockage factor is the premium or discount based on the relative size of positions, such as a large proportion of the total trading units of an instrument. IAS 39 states that the existence of published price quotations in an active market is the best evidence of fair value and when they exist, they are used to measure the financial assets and financial liabilities (IAS 39 AG71). As such, the use of a blockage factor is not appropriate in the determination of fair value. Bid and asking prices should be used regardless of the valuation method prescribed by the offering document and it can result in different net asset values between and the offering document. Please see "Net Asset - Measurement" below for further discussion.

29 27 For investments without an active market, their fair value should be determined based on a valuation technique. The valuation technique can be based on market transactions of substantially similar securities, discounted cash flow analysis, an option pricing model, or other valuation technique commonly used by market participants and proven to be reliable (IAS 39, AG 74). For investments listed in an active market, the use of bid or asking price, last price, mean between bid and asking price, or a valuation within the range of bid and asking prices is permitted. Each of those policies is acceptable if applied consistently in accordance with the investment fund's established pricing policy and its offering document. Neither the use of the asking price alone to value investments, nor the use of the bid price alone to value short positions, is acceptable (AAG-Inv ). specifically does not allow the application of a blockage factor to unrestricted investments that have a quoted price in an active market, unless it was a fund's accounting policy in its financial statements issued for fiscal years ending on or before May 31, 2000 to do so (AAG-Inv 7, Footnote 20). The use of a blockage factor, if any, should be disclosed. This policy must be fully discontinued upon adoption of FASB Statement No. 157, Fair Value Measurement (see below). For securities without an active market, fair value should be estimated in good faith by the board of directors or its designee (AAG-Inv 2.35). AAG-Inv specifically states that no single method exists for estimating fair value in good faith because fair value depends on the facts and circumstances of each individual case (AAG-Inv 2.38). However, the board of directors should be satisfied that the method used to estimate fair value in good faith is reasonable and appropriate and the resulting valuation is representative of the fair value. FAS 157, which will be effective for the fiscal year beginning after November 15, 2007, provides further guidance on the measurement of fair value under. This standard is designed to define how fair should be determined. FAS 157 establishes a fair value hierarchy, which has three levels: 1) Level 1 consists of quoted prices in active markets for identical assets and liabilities; 2) Level 2 consists of the use of inputs other than quoted prices included within Level 1 that are observable directly or indirectly; and 3) Level 3 permits the use of "unobservable inputs, which represents the entity's own assumptions of inputs that approximate those market participants would use.

30 28 The fair value hierarchy is not significantly different from the guidance in, which states that quoted prices in an active market are the best evidence of fair value and in the absence of quoted prices, quoted prices of similar instruments (similar to Level 2 in FAS 157) or a valuation technique (similar to Level 3 in FAS 157). However, FAS 157 requires the use of an "exit price" in valuation. The notion of exit price does not necessarily require the use of bid or asking prices. Rather, for Level I inputs, FAS 157 calls for the use of "the price within the bid-ask spread that is most representative of fair value in the circumstances," and "does not preclude" the use of mid-market prices or other "conventions as a practical expedient" for fair value measurement within a bid-ask spread. Financial Instruments - Disclosure Please note that the following discussion is based on 7, Financial Instruments: Disclosure. 7 is effective for annual periods beginning on or after January 1, 2007 but early adoption is encouraged ( 7.43). The objective of 7 is to provide disclosures "through the eyes of management" such that users are able to evaluate the nature and extent of risks arising from financial instruments to which an investment fund is exposed at the reporting date and how the risks are managed. Balance Sheet 7 requires disclosure of the carrying values of each of the following categories either on the face of the balance sheet or in the notes ( 7.8): 1) Financial assets at fair value through profit or loss, showing separately those designated upon initial recognition and those classified as held for trading; 2) Held-to-maturity investments; 3) Loans and receivables; 4) Available-for-sale financial assets; 5) Financial liabilities at fair value through profit or loss, showing separately those designated upon initial recognition and those classified as held for trading; and 6) Financial liabilities measured at amortised cost. Fair value of each of the categories of financial assets and liabilities, including the assumptions and estimations used in the determination of fair value, should be disclosed. If fair value cannot be determined, that fact should be disclosed ( 7.25). For an investment fund, as investments are generally carried at fair value and its other financial assets and liabilities are short term in nature, the carrying amounts of other financial assets and liabilities typically approximate the fair value and it should be stated in the notes to the financial statements ( 7.29).

31 29 Collateral pledged, including carrying amounts and terms and conditions should be disclosed ( 7.14). Collateral held, including the fair value, the fair value of any such collateral sold or repledged, whether the entity has an obligation to return it, and terms and conditions should be disclosed ( 7.15). Income Statement 7 requires the disclosure of net gains or losses on each of the categories of financial assets and liabilities (see Balance Sheet above). Total interest income and interest expense should be disclosed for financial assets and financial liabilities that are not at fair value through profit or loss. Any impairment loss for each category should also be disclosed. Nature and Extent of Risks Arising from Financial Instruments To help users understand the nature and extent of risks arising from financial instruments, both qualitative and quantitative disclosures should be made. The risks for an investment fund usually include credit risk, liquidity risk, market risk, interest rate risk, and currency risk. The nature and extent of risks should be customised and additional risks may be identified and disclosed based on specific investment objectives and activities of an investment fund. 7 provide minimum items, including sensitivity analyses, to be disclosed in 7.33 to Illustrative Financial Statements Investment Funds provides examples of disclosure in accordance with 7. Please refer to 7 for other items that may be required due to an investment fund's specific situations and circumstances. 7 is to provide guidance for general enterprises and is not developed specifically for investment funds. In addition to 7, IAS 1 also requires the disclosure of the use of judgment that management has made in the application of accounting policies and that have the most significant effect on the amounts recognised in the financial statements (IAS 1.113). Furthermore, key assumptions used and key sources of estimation of uncertainty should also be disclosed together with the nature and carrying amounts of the affected assets and liabilities (IAS 1.116) The approach is different from and the level of disclosures is different under these two accounting standards. The disclosure requirements under are more specific and customised to industry practice, while provides general requirements and requires the disclosure to be made through the eyes of management.

32 30 The disclosure requirements are mostly included in, but not limited to, AAG-Inv and the following (AAG-Inv 7.79): 1) FAS 107, Disclosures about Fair Value of Financial Instruments; 2) FAS 133, Accounting for Derivative Financial Instruments and Hedging Activities; and 3) SOP 94-6, Disclosure of Significant Risks and Uncertainties. The above standards require the disclosure of fair value, concentration of credit risk, market risk, off-balance sheet risk, significant estimates, key assumptions used in the determination of fair value and resulted uncertainties, etc. Financial Instruments - Offsetting A financial asset and a financial liability should be offset and the net amount presented on the balance sheet when a fund (IAS 32.42): 1) Currently has a legally enforceable right to set off the recognised amounts; and 2) Intends to settle on a net basis, or to realise the asset and settle the liability simultaneously. A fund needs to have a currently legally enforceable right to set off in order to offset financial assets and financial liabilities. The fund may have a conditional right to set off recognised amounts, such as in a master netting agreement, but such rights are enforceable only on the occurrence of some future event, usually a default of the counterparty. does not consider such an agreement as meeting the conditions for offset (IAS 32, AG 38). As a result, unrealised appreciation of derivatives should not be offset against the unrealised depreciation of derivatives even if such derivatives have the same counterparty and they should be presented as financial assets and financial liabilities on the balance sheet, respectively. The right to set off exists when all the following conditions are met (FIN 39.5): 1) Each of two parties owes the other determinable amounts; 2) The reporting party has the right to set off the amount owed with the amount owed by the other party; 3) The reporting party intends to set off; and 4) The right of setoff is enforceable at law. However, specifically allows that fair value amounts recognised for derivative contracts executed with the same counterparty under a master netting arrangement are assumed to meet the intention requirement and therefore may be offset if the other three conditions are met. The fund's choice to offset or not must be applied consistently (FIN 39.10).

33 31 Fixed Income Securities - Discounts and Premiums requires interest to be recognised using the effective interest method as set out in IAS 39 paragraphs 9 and AG5-8 (IAS 18.30a). As such, the discount and premium of fixed income securities should be included in the calculation of interest income under the effective interest method. does not require interest income and foreign currency exchange gains and loss on financial assets and liabilities carried at fair value through profit or loss to be separately disclosed. For available for sale fixed income securities, a gain or loss shall be recognised directly in equity, except for impairment losses and foreign exchange gains and losses. The interest calculated using the effective interest method is also recognised in profit and loss for available for sale fixed income securities. To calculate the foreign exchange component, such debt securities should be treated as if they were carried at amortised cost in the foreign currency (IAS 39 AG83). The effective interest method is based on the expected future cash flows without considering future credit losses (IAS 39.9). However, in some cases, investments are acquired at a deep discount that reflect incurred credit losses and such incurred credit losses should be included in the estimated cash flows (AG5). Similar to, discounts and premiums, except in the case of defaulted securities, should be amortised using the effective interest method (AAG-Inv 2.53). Defaulted debt securities are often acquired at a deep discount due to incurred credit loss and no expectation of interest payments. Their computed yield to maturity may be higher than rates expected to be ultimately realised (AAG-Inv 3.22). Similar to, no amortisation should be recorded due to no expectation of interest income and due to the objective of capital appreciation. Unlike, interest income of investments, with the amortisation of discounts and premiums where applicable, is disclosed separately as interest income in the income statement.

34 32 Balance Sheet - Net Assets Net Assets - Classification The definition of a financial liability includes a contractual obligation to deliver cash or another financial asset to another entity (IAS 32.11). IAS 32 states that a financial instrument that gives the holder the right to put it back to the issuer for cash and another financial asset (a "puttable instrument") is a financial liability regardless whether the amount of cash and another financial asset is determined based on an index or other item that has the potential to increase or decrease. IAS 32 further specifically cites, as examples of puttable instruments, interests issued by open-ended mutual funds, unit trusts, partnerships, etc. (IAS 32.18). Shares, units or interests issued by an open-ended investment fund are typically redeemable by their holders. Those issued by a private equity fund or a closed-end fund with a limited life are generally required to be redeemed at a specific date and upon its redemption, the fund has a contractual obligation to deliver cash or financial assets to its shareholders. As such, these instruments should be classified as financial liabilities, not equity, in accordance with the provisions of IAS 32. Classification of shares, units or interests as financial liabilities may result in an investment fund having no equity or minimal equity (typically in form of voting non-participating shares in case of an offshore fund). Further, distributions made by an investment fund to its redeemable shares, which are classified as financial liabilities, should be recorded as financing cost in the profit and loss. Please see "Balance Sheet", "Statement of Changes in Equity" and "Financial Instruments - Subsequent Measurement" above for further discussion of the implications of such classification. On June 22, 2006, the IASB issued an Exposure Draft, Proposed Amendments to IAS 32 Financial Instrument: Presentation and IAS 1 Presentation of Financial Statements - Financial Instrument Puttable at Fair Value and Obligations Arising on Liquidation, in which the definition of a financial liability will be amended to exclude puttable instruments which meet specified criteria. The amendment will also cover obligations that arise upon liquidation. As a result, upon the adoption and approval of the Exposure Draft, which is currently in the discussion phase, an investment fund may be able to classify its shares or interests as equity instead of as financial liabilities as currently required under IAS 32 if all the conditions are met. Shares or other interests issued by an open ended investment fund are typically classified as "net assets attributable to holders of redeemable shares". The amount of shares redeemed effective prior to a period end but to be paid after year end typically is classified as redemptions payable.

35 33 The shares, units or interests issued by an investment fund continue to be classified as equity, except for the requirements of FAS 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity. FAS 150, as affected by FASB Staff Position No. FAS 150-3, requires a financial instrument mandatorily redeemable on fixed dates for amounts that are either fixed or are determined by reference to an interest rate index, currency index or another external index, to be classified as a liability unless the redemption is required upon the liquidation or termination of the reporting entity (FAS 150.9). Shares or interests of an investment fund are subject to redemption at the option of the holders. Shares or interests to be redeemed due to a irrevocable redemption request made prior to a reporting period end for a redemption effective immediately after period end and to be paid after period end at an amount determined based on the NAV at period end are considered financial liabilities under FAS 150 and classified as redemptions payable. As a result of the differences in the definition of a financial liability, net assets and redemptions payable under may be different from those under. Net Assets - Measurement Net assets attributable to holders of redeemable shares represent a liability on the balance sheet, carried at the redemption amount that would be payable at the balance sheet date if the holders exercised the right to put the shares back to the fund. Although shares or interests are classified as financial liabilities, net assets represent the residual interest in the assets of an investment fund, which should represent the carrying amount of the net assets at initial and subsequent measurement. Due to the requirement to value investments at bid price or asking price for long and short positions, respectively, the value of net assets under may be different from the value of net assets determined based on the fund's offering memorandum, which may use another valuation basis (such as valuing investments at last price). The net asset value as determined based on the offering memorandum may further be the amounts used in the fund's subscriptions and redemptions. As such, there may be a difference in measurement of net assets attributable to holders of redeemable shares between the measurement in accordance with and the measurement in accordance with the offering memorandum. These differences between the net asset value under and under the offering memorandum should be disclosed. Furthermore, the differences adjust the carrying amount of the shares and are recognised as expense in the income statement. Please see the International Financial Reporting Standards Illustrative Financial Statements Investment Funds for example of presentation.

36 34 Net assets represent the residual interests in the assets of an investment fund, which should represent the carrying amount of the net asset at initial and subsequent measurement. Income Statement Interest and Dividend Income Recognition Since allows more discretion in valuing investments (bid price, asking price, last price, etc., please see "Financial Instruments - Fair Value" above) most funds' offering memoranda prescribe one of the bases allowed under, there is usually no difference in net asset value. Interest should be accrued and recognised using the effective interest method (IAS a) from the post-acquisition date (IAS 18.32) and dividends should be recognised when the right to receive payment is established (IAS c), which is typically on ex-dividend date. Similar to, interest should be accrued using the effective interest method (i.e., discounts and premiums, if any, should be amortised) (AAG-Inv 2.53). Dividends should be accrued on ex-dividend date (AAG-Inv 2.47). Realised and Unrealised Gains (Losses) on Investments - Presentation Although not as a minimum item to be presented under IAS 1, net gains or losses on investments should be presented on the face of the income statement given their importance to a fund's financial performance. Interest income does not need to be disclosed separately for financial instruments at fair value through profit or loss and may be included in the gains or losses on investments. There is no requirement to separate realised and unrealised gains or losses. Realised gains or losses (AAG-Inv 7.51) and unrealised appreciation or depreciation on investments should be disclosed separately (AAG-Inv 7.54) as they are individual items to be presented in a statement of operations as required by AAG-Inv (please see "Income Statement" above). Interest income should be disclosed separately in the income statement. Net Gains (Losses) on Foreign Exchange - Presentation Gains or losses on foreign exchange should be disclosed separately (IAS 21.52) except when at fair value through profit or loss (IAS a). There is no requirement to show realised and unrealised foreign exchange gains or losses separately as in. There are two main types of foreign exchange gains or losses (AAG-Inv 7.52, 7.54 and 7.55):

37 35 1) Net gains or losses from foreign currency transactions; and 2) Net gains or losses from the foreign currency element of investment gains and losses, which may either be presented separately or together with net gains (losses) on investments (almost universal practice is to present them together). Other Accounting and Reporting Topics Functional Currency Functional currency is the currency of the primary economic environment in which an investment fund operates (IAS 21.9). IAS 21 lists several factors (such as sale prices, costs, etc.) as primary indicators in the determination of functional currency (IAS 21.9). However, these factors are not readily applicable to an investment fund. Financing is considered a secondary indicator (IAS 21 (IAS 21.10). An example for financing is the currency in which the investment fund's shares are issued and redeemed. As a result, determining the functional currency is not straightforward and depends on multiple factors, including but not limited to: 1) the economic environment(s) in which the financial assets are invested; 2) the economic environment(s) of the investors; 3) the regulatory environment; 4) the competitive environment; 5) the fee structure; and 6) the denomination of subscriptions and redemptions. When the factors are mixed and the functional currency is not obvious, management should use its judgment to determine the functional currency that most faithfully represents the economic effects of underlying transactions, events and conditions (IAS 21.12). When the presentation currency is different from the functional currency, disclosure should be made for the investment fund's functional currency and the presentation currency, which is the currency used in the presentation of financial statements. The reason for the difference should be disclosed. Similar to, the functional currency is the currency of the primary economic environment in which an investment fund operates. Factors are listed in Appendix A of FAS 52, Foreign Currency Translation. However, US GAAP has no hierarchy of indicators. Investment funds typically do not disclose functional currency or presentation currency as would be required under. Similar to, management is required to use its judgment to determine the functional currency.

38 36 Foreign Currency Transactions A foreign currency transaction should be recorded, on initial recognition in the functional currency, by applying to the foreign currency amount the spot exchange rate at the transaction date (IAS 21.21). At subsequent balance sheet dates, monetary assets and liabilities denominated in a foreign currency are translated using the closing rates (IAS a). Non-monetary balance sheet items that are measured at historical cost in a foreign currency should be translated using the exchange rate at the date of transaction (IAS b). Non-monetary balance sheet items that are measured at fair value in a foreign currency should be translated at the exchange rate at the date when the fair value is determined (IAS c). The general principles of foreign exchange translation are similar to. At initial recognition, a foreign currency transaction is recorded and translated at the spot exchange rate at the transaction date. Subsequent measurement of foreign currency denominated balances is in general similar to. The historical exchange rate is generally used for non-monetary accounts as defined in Appendix B of FAS 52 and the current rate is used for all other accounts. Realised gains or losses from foreign investments and transactions are comprised of two components, changes in foreign exchange rate and foreign market price. Separately reporting gains or losses from these two components or presenting them together is allowable (AAG-Inv 2.74). Similarly, unrealised gains on foreign investments can be combined together or "bifurcated" (i.e., separately disclosing unrealised gains or losses on foreign exchange) (AAG-Inv 2.75 and 2.76). Nearly universal practice is to present the two components together. In this respect, as under investments are classified as financial instruments at fair value through profit or loss, the gains or losses on foreign exchange are combined with those resulting from change in foreign market price as under. AAG-Inv provides further guidance on foreign exchange translation on other financial statement items (AAG-Inv 2.80 to 2.98). Please see the Section "Gain on Foreign Exchange - Presentation" above for further discussion. Foreign Currency Translation When translating the financial statements of an entity from the functional currency into the presentation currency assets and liabilities shall be translated at the closing rate and income statement items shall be translated at exchange rates at the dates of the transactions. The resulting exchange differences shall be recognised as a separate component of equity.

39 37 Income statement amounts are translated using historical rates of exchange at the date of transaction or an average rate as a practical alternative, provided that the exchange rate does not fluctuate significantly (IAS 21.22). Similar to. However in practice it is rare for an investment fund which prepares its financial statements under to translate its financial statements into a presentation currency other than its functional currency, or consolidate another entity with a different functional currency which would require the application of the guidance under FAS 52 for foreign currency translation which is similar to. NAV per Share The disclosure of NAV per share is not required under. However, it is common practice to disclose NAV per share. NAV per share is required to be disclosed for each class of shares in issuance. Earnings per Share If an investment fund has equity instruments that are publicly traded, EPS should be disclosed in accordance with IAS 33, Earnings per Share. Not required. Financial Highlights The disclosure of financial highlights is not required and typically, funds reporting under do not disclose financial highlights information. The disclosure of financial highlights is required under, either as a separate schedule or within the notes to the financial statements (AAG-Inv 7.73). Financial highlights should be provided for each permanent class of shares outstanding related to the non-managing investors (AAG-Inv 7.73). For unitised funds, financial highlights should include per share information (AAG-Inv 7.74), ratios of expenses (before and after incentive fees) and investment income or loss to weighted average net assets (AAG-Inv 7.75), and total return (based on net asset value per share, before and after incentive fees) (AAG-Inv 7.76.a). The required disclosure of per share information is comprised of net asset value at the beginning of period, net investment income or loss, realised and unrealised gains and losses, total from investment operations, distributions, and net asset value at the end of period. For non-unitised funds, in addition to ratios of expenses (before and after incentive allocation) and investment income or loss, total return should be presented based on the change in value during the period of a theoretical investment made at the beginning of the period (AAG-Inv 7.76c).

40 38 For funds of funds, the expense ratios should not include the proportionate share of expenses of underlying investee funds (AAG-Inv 7.75.c) For private equity funds (and certain other limited life entities) which invest substantially in non-marketable securities, the internal rate of returns, net of all incentive fees or allocations for each investor class (AAG-Inv 7.76.d), is presented as of the beginning and end of the fiscal year instead of the annual total return. Additionally, such funds also disclose total committed capital, the year of formation and the ratio of total contributed capital to total committed capital in the financial highlights or elsewhere in the notes to the financial statements (AAG-Inv 7.75.b). Related Party Transactions Related party is defined in paragraph 9 of IAS 24, Related Party Disclosures. The disclosures required for related party transactions, typically applicable to an investment fund, are as follows (IAS 24.17): 1) The amount of transactions; 2) The amount of outstanding balances and a. Their terms and conditions; b. Details of any guarantee received or given; 3) Provisions for doubtful debts related to the amounts of outstanding balances; and 4) The expense recognised in respect of bad or doubtful debts due from related parties. An investment fund generally follows the above principles in its disclosure of related party transactions. Related party is defined in paragraph 24.e of FAS 57, Related Party Disclosures. The definition is similar to that under. In accordance with FAS 57, the following should be disclosed for related party transactions (FAS 57.2): 1) The nature of relationships; 2) A description of the transactions, including transactions to which no amounts or nominal amounts were ascribed; 3) The dollar amounts of the transactions; and 4) Amounts due from and to related parties. Furthermore, if an investment fund and one or more other parties are under common ownership or management control and the existence of that control could result in operating results or financial positions of the investment fund significantly different from those that would be obtained if the investment fund is autonomous, the nature of the relationship should be disclosed even though there are no transactions between the parties (FAS 57.4).

41 39 For an investment fund, the major related transactions are management fees, incentive fees (or allocation), and administration fees. AAG-Inv requires that all amounts paid to affiliated or related parties be disclosed in accordance with FAS 57. It further specifically states that significant provisions of related party agreements, including the basis of determining management, advisory, administration, or distribution fees, and other amounts paid to affiliates or related parties should be described in a note to the financial statements (AAG-Inv 7.44). Segment Reporting For investment funds listed and traded on an exchange, the segment reporting is required. Under IAS 14, Segment Reporting, a segment is either a business segment or a geographic segment. One of the segments will be a primary segment and the other will be secondary. The accounting policies to determine a segment should be disclosed. Disclosure requirements for the primary segment are detailed in paragraphs 51 to 67 of IAS 14. If the primary segment is the business segment, additional disclosure requirements for geographic segment, as detailed in paragraphs 69 to 72, should be met as well. Please see International Financial Reporting Standards Illustrative Financial Statements Investment Funds for example of segment reporting under IAS 14. On November 30, 2006, the IASB issued 8, Operating Segments, which will replace IAS 14 and will be effective for the year beginning on or after January 1, Under 8, a segment is an operating segment, which is identified on the basis of internal reports that are regularly reviewed by an entity's chief operating decision makers in order to allocate resources to the segment and assess its performance. Measurement and disclosure requirements have also been amended. The segment reporting under 8 is to disclose an entity's segment through the eye of management. Not required.

42 40 Investment Management Industry Champions If you would like to discuss any aspect of this document, please speak to your usual contact within the network of member firms of International Limited or one of those listed below: Global Leader for the Investment Management Industry Marie-Anne Kong Telephone: Australia Craig Stafford Telephone: [email protected] Bermuda Andrew Brook Telephone: [email protected] Canada Raj Kothari Telephone: [email protected] Cayman Islands Paul Donovan Telephone: [email protected] Channel Islands Brendan McMahon Telephone: [email protected] Denmark Michael Jacobsen Telephone: [email protected] France Marie-Christine Jetil Telephone: [email protected] Germany Anita Dietrich Telephone: [email protected] Hong Kong Marie-Anne Kong Telephone: [email protected] Ireland Jonathan O'Connell Telephone: [email protected] Luxembourg Mark Minet Telephone: [email protected] Netherlands Frank van Groenestein Telephone: [email protected] Singapore Peter Low Telephone: [email protected] South Africa Pierre De Villiers Telephone: [email protected] Switzerland Thomas Huber Telephone: [email protected] United Kingdom Marcus Hine Telephone: [email protected] USA Thomas Romeo Telephone: [email protected] If you would like additional copies of this survey please contact Merryn Stewart at [email protected].

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