Complexities in Management Company Accounting — and How to Get It Right

Management companies that oversee investment funds often find themselves navigating a unique and complex accounting landscape. While affiliated funds typically follow ASC 946, Financial Services — Investment Companies, management companies do not apply that specialized framework. This divergence and complexities inherent in management companies creates accounting challenges that, if not carefully managed, can lead to financial reporting inconsistencies, compliance issues or operational inefficiencies.

Below are several common pitfalls management companies face and practical solutions that can help avoid them.

1. Consolidation and Variable Interest Entities (VIEs)

The challenge:
One of the most significant and commonly misunderstood issues for management companies relates to ASC 810, Consolidation, particularly the VIE model. Consolidation ensures that the financial statements reflect the true economic substance of relationships between entities. If a management company controls another entity (for example, through ownership or decision-making authority), its assets, liabilities, income and expenses must be included in consolidated financial statements.

Careful evaluation of the relationships of the management company must be made. Evaluation of the investment fund receiving services from the management company is evaluated with emphasis placed on  guidance in ASC 810-55-37, which requires careful evaluation of fee arrangements. While management fees may appear to be “market-based compensation,” combining these with other rights or incentives can create a variable interest that may change the consolidation conclusion. In addition, when the manager is also the general partner of an investment fund additional evaluation should be made as the exception provided by ASC 810-55-37 does not apply in these situations. This evaluation may be complex based on the terms of the arrangement with the fund, governance structure and ownership of the general partner. 

In other words, when viewed collectively, a GP’s compensation and ownership structure may indicate both power and exposure to significant economics, triggering consolidation under the VIE model. Many management companies fail to consider the aggregate effect of these arrangements, leading to incorrect conclusions about whether the fund or the general partner should be consolidated. In many situations the investment fund is not consolidated with the management company if the only interests are related to the management or incentive fees paid, however, the evaluation will have to take into account all interests. Evaluation of the general partner is typically more complex and many times results in consolidation with the management company.

2. Revenue Recognition under ASC 606

The challenge:
Management companies typically earn revenue from management fees, performance or incentive allocations and reimbursement of investment fund expenses. Determining when and how to recognize these revenues under ASC 606, Revenue from Contracts with Customers, can be complex.

• Variable consideration (such as performance or incentive fees) often depends on market performance and typically will not be recognized until contingencies are resolved and the amount to be received is known.
• For open-ended funds, these fees are recognized only when performance is finalized or crystallized, typically at the end of the measurement period, because results can fluctuate and reverse. In contrast, for closed-ended funds, incentive fees are recognized when performance hurdles are met and the amounts are no longer subject to clawback, often upon realization of investments. The key difference is timing — open-ended fund fees are typically recognized annually when crystallized, while closed-ended fund fees usually require deferral and are recognized once earned and collected.
• Reimbursable expenses must be assessed to determine whether the management company acts as a principal or an agent.
• Side agreements or clawback provisions can further complicate timing and measurement.

3. Equity Method Investments

The challenge:
When management companies hold noncontrolling interests in funds or affiliates, ASC 323, Investments — Equity Method and Joint Ventures, may apply once it has been determined that the investment is not a variable interest entity that should be consolidated.

• Determining whether the equity method applies (and what adjustments are needed for basis differences or capital withdrawals) can be nuanced.
• Some companies mistakenly record these investments at cost or fail to recognize their share of income and losses appropriately.

4. Lease Accounting under ASC 842

The challenge:
Office leases, equipment rentals and even related-party agreements can fall under ASC 842, Leases. Historically, operating leases, such as office leases, were not recorded on the balance sheet, which changed under the provisions of ASC 842. Many management companies underestimate the scope of ASC 842 and the impact of recording right-of-use (ROU) assets and lease liabilities, particularly for related-party leases that lack formal documentation.

Practical Alternatives When a US GAAP Audit Isn’t Required

Not every management company needs a full U.S. GAAP audit. However, investors, lenders and regulators often still expect transparency and credibility. There are several other reporting frameworks that a management company can use that strike the right balance between rigor and practicality:

• Modified cash basis financial statements: Ideal for owner-managed entities seeking a financial reporting framework that focuses on changes in cash balances
• Tax-basis financial statements: Useful for companies that align their accounting with income tax reporting, providing consistency between financial statements and tax returns while reducing the cost and complexity of GAAP compliance
• Agreed-upon procedures (AUP) engagements: Targeted assurance on specific areas, such as fee calculations, related-party transactions or internal controls
• Compilation or review services: Providing confidence and reliability in financial data without the cost and scope of an audit
• Policy and process consulting: Helping management companies design accounting policies and documentation that satisfy investor and compliance expectations

Final Thoughts

Accounting for management companies requires the application of some complex areas of GAAP which demands a nuanced understanding of how these entities operate alongside investment funds. Missteps in revenue recognition, consolidation or lease accounting can have material consequences.

At Weaver, we combine deep technical experience with practical, right-sized solutions to help management companies meet their needs efficiently and accurately. Whether through an audit, tax, financial reporting, internal controls or agreed-upon procedures, we tailor our approach to fit your business and its stakeholders. Contact us to learn more.

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