AICPA Revenue Recognition Working Group releases compliance concerns for fund managers

The American Institute of Certified Public Accountants’ (AICPA) Revenue Recognition Task Forces have been issuing industry specific guidance related to Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 606, Revenue from Contracts with Customers. Several of these issues relate specifically to fund managers and should be considered when implementing the new revenue recognition standard.

Identification of issues for fund managers with implementation

To help provide ASC 606 implementation resources to the affected industries, the AICPA created industry-specific revenue recognition task forces. The Asset Management Revenue Recognition Task Force, comprised of leaders from various accounting firms and investment management companies, identifies potential implementation issues and provides helpful insight / examples to assist companies in implementation.

The task force identified nine key areas that have potential implementation issues for fund managers. Three of these nine topics, along with their respective insights, have been finalized and included in the AICPA guide on Revenue Recognition while two additional topics have been submitted for review to the AICPA Revenue Recognition Working Group. However, several topics are currently out for exposure (comment period ends August 1, 2017) and potentially subject to change:

• Topic 2: Management Fee Revenue, excluding Performance Fee Revenue – Expected Overall Level to Industry Accounting: Moderate
• Topic 3: Management Fee Waivers and Customer Expense Reimbursements – Expected Overall Level to Industry Accounting: Minimal
• Topic 5: Incentive or Performance Fee Revenue, excluding incentive-based capital allocations (such as carried interest) – Expected Overall Level to Industry Accounting: Minimal
• Topic 5A: Incentive-Based Capital Allocations – Expected Overall Level to Industry Accounting: Significant

Of the topics mentioned above, the AICPA Financial Reporting Executive Committee (FinREC) has named Topic 5A – Incentive-Based Capital Allocations as the area having the highest possibility of being significant to industry accounting.

Topic 5A: Incentive-based capital allocations

If an incentive-based capital allocation exists under the scope of ASC 606, an entity shall include in the transaction price (i.e., defined as the amount of consideration to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer, excluding amounts collected on behalf of third parties) some or all of an amount of variable consideration estimated in accordance with FASB ASC 606-10-32-8. However, this is applicable only to the extent that it is probable a significant reversal in the amount of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is subsequently resolved.

Incentive fees are typically variable revenue arrangements, as they are dependent on certain events occurring. ASC 606-10-32-8 requires the amount of variable consideration be estimated using one of the following two methods, depending on which method the fund manager expects to better predict the amount of consideration it will be entitled:

• The expected value of the contract determined by the sum of probability-weighted amounts in a range of possible consideration amounts.
• The most likely amount equal to the single most likely amount in a range of possible consideration amounts.

Considerations

In accordance with ASC 606-10-32-9, the fund manager should consider all of the information – historical, current and forecast – that is reasonably available to the entity, including its historical experience with similar arrangements in similar jurisdictions to determine the estimate of variable consideration. Consideration should be given to the accuracy of previously forecasted results and actual fund performance to help determine if there is a range of possible consideration amounts that could be used to derive the expected value (i.e., in a probability-weighted estimate) or most likely amount to which the entity will be entitled.

This treatment includes consideration that it is probable there will not be a significant reversal in the amount of cumulative revenue recognized, which can include factors such as:

• The extent to which the underlying investment portfolio is subject to future changes (e.g., market volatility and investment and reinvestment)
• The extent to which there is a return on investment in excess of the contractual hurdle rate
• The time remaining in the performance period

When evaluating these arrangements, the asset manager should consider the nature of the incentive-based capital allocation specifically in regard to:

• The inputs of the calculation of the incentive-based capital allocation and the dependence of the ultimate incentive-based capital allocation on other factors, such as investment company performance waterfalls, hurdle rates (e.g., variable, index, fixed, etc.), or investment-by-investment calculations
• The existence of clawback or other similar provisions

These arrangements will require a high degree of management judgment and evaluation of relevant data and the specific terms of their contracts to ensure they are appropriately in compliance with the performance-based arrangement criteria of ASC 606.

Baker Tilly encourages fund managers who engage in incentive-based capital allocations to begin familiarizing themselves with this topic well ahead of the required implementation date.

For more information on ASC 606, or to learn how Baker Tilly's asset management industry specialists can help, contact our team.