The how and why of special purpose financial statements has been saved
Perspectives
The how and why of special purpose financial statements
When a general purpose framework doesn’t satisfy user needs
When financial services entities need to create financial statements tailored to specific purposes or users, they may choose an alternative reporting approach using another comprehensive basis of accounting. These instances may call for special purpose financial statements, prepared on a cash, modified cash, tax, regulatory, or contractual basis. Explore common questions and challenges financial professionals face when preparing special purpose financial statements.
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When to consider special purpose financial statements
Your entity may prepare financial statements for a specific group of users, such as regulators, banks, real estate landlords, family member owners, or investors/customers. Special purpose financial statements can often be more relevant and less costly to prepare than GAAP- or IFRS-compliant financial statements, depending on their intended use.
We see this most often considered when certain financial services entities are privately held and have no regulatory reporting requirements. For these entities, there is no need to file reports with the Securities and Exchange Commission (SEC) that would require SEC and GAAP or IFRS-compliant financial statements. Additionally, special purpose financial statements can still be subject to independent review or audit procedures with the applicable basis of accounting applied.
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While cash and tax basis are most common, financial services firms also use the contractual basis for special purpose financial statements when the following are present:
- Complex or unique compensation and share-based equity arrangements
- Contract provisions requiring unique financial reporting calculations, e.g., partnership, line of credit, or service agreements
- Users who prefer unconsolidated financial statements so they can better understand the reporting entity’s operational and economic results
- Users who want the option to separately disclose accounts normally presented together
- Users who prefer unconsolidated financial statements so they can better understand the reporting entity’s operational and economic results
- Users who prefer unconsolidated financial statements
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Typical special purpose exceptions
No established standards exist for determining appropriate modifications in special purpose financial statements. However, we’ve seen certain modifications used more regularly depending on the industry. For financial service entities who choose to use special purpose financial statements, specifically under a contractual basis, the table below highlights common modifications.
Impacted areas
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Investments and loans
- Elect to report investments in other entities at cost, fair value, or equity method, instead of a consolidated basis; accounting for certain investments at cost or using the equity method can lead to a more useful financial statement presentation for financial services entities that have small equity stakes but direct the significant activities of the funds they manage on behalf of fund investors
- Elect to report investments at historical cost instead of fair value or another appropriate amount
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Compensation and benefits
- Reflect partner distributions and/or withdrawals as equity transactions instead of compensation expense
- Treat bonuses and other compensation plans as cash bonuses
- Treat share-based compensation as cash bonuses, valued on the vesting date
- Record pension liabilities at the amount determined to be tax deductible
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Other areas
- Decide against gross presentation of expenses paid on behalf of the funds, and the subsequent reimbursement
- Include only deferred revenue and other journal entries that impact cash
- Decide against adopting ASC 842 or IFRS 16
- Recognize transactions when and in the amount that they would be recognized in the company’s tax return
- Account for certain items (leases, contingent liabilities, depreciation, interest expense, etc.) under Internal Revenue Code rules
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Common stumbling blocks
Special purpose financial statements can lead to challenges and confusion since there is no established standard for preparation. For entities accounting on a cash basis, it is also possible to manipulate timing of receipts and distributions, failing to provide a complete picture of the entity’s economic condition. And there is always a chance they do not meet certain user or regulatory requirements, should the entity go public or later have investors or lenders who require GAAP or IFRS-compliant financial statements.
For example, suppose a financial services entity finds itself having to unwind its special purpose financial statements. This could happen if the entity goes public or sells itself to another entity. It could also happen if a regulator—or a new counterparty—requires GAAP or IFRS-compliant financial statements.
To convert from special purpose financial statements to financial statements prepared under GAAP or IFRS, or vice versa, you need to know the differences between current and GAAP or IFRS presentations and how many periods to present. You may also need to determine whether:
• Certain specialists need to be involved
• An audit is required and for how many periods
Applying the excluded or modified topics of a generally accepted accounting framework can get complicated fast. It often gets into complex accounting that may need considerable judgment, and when it comes to applying special purpose accounting frameworks, there’s isn’t standard authoritative guidance. Accounting advisers can help evaluate whether an applied framework is suitable for the users of the financial statements and help a company understand any necessary adjustments.
For questions about special purpose financial statements or help with preparation or unwinding this type of reporting, please contact:
Recommendations
2020 Investment Management Accounting Guide
Investment Management Accounting and Financial Reporting Update
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