ASC 946 Investment Company Accounting: Scope and Statements

ASC 946, Financial Services - Investment Companies, sets the accounting and reporting for entities that are investment companies for GAAP purposes. It applies to private equity and venture funds, hedge funds, funds of funds and many other pooled vehicles, and it differs from ordinary GAAP in two ways that drive the audit: investments are carried at fair value with changes in earnings, and the investment company generally does not consolidate the entities it controls.

A CPA firm's fund clients raise the same recurring question first: is the entity an investment company at all? ASU 2013-08 gave a two-tier test, covered below. This page also covers the required statements and the audit areas that follow.

Is the entity an investment company?

Regulated entities. An entity regulated under the Investment Company Act of 1940 is an investment company under Topic 946 (946-10-15-4).

Unregulated entities assess the characteristics in 946-10-15-5 through 15-8.

Fundamental characteristics, all of which must be present (946-10-15-6):

The entity obtains funds from investors and provides them with investment management services, and commits to its investors that its business purpose and only substantive activities are investing the funds solely for returns from capital appreciation, investment income, or both.
The entity, or its affiliates, does not obtain or seek returns or benefits from investees other than capital appreciation or investment income. Benefits that are not normally attributable to ownership interests do not fit.

Typical characteristics (946-10-15-7). An investment company typically has more than one investment, more than one investor, investors that are not related parties of the parent or investment manager, ownership interests in the form of equity or partnership interests, and substantially all investments managed and evaluated on a fair value basis. Under 946-10-15-8, the absence of a typical characteristic does not necessarily preclude investment company status. It calls for judgment.

Implementation guidance in 946-10-55 adds detail. Exit strategies are needed for investments held for capital appreciation, and disposal only on liquidation or to meet redemptions is not an exit strategy. An entity should have no substantive activities beyond investing, and benefits such as options to buy investee assets at other than fair value, or joint development with investees, point away from investment company status. Related investors are combined and treated as one for the assessment.

Status is reassessed only if the entity's purpose and design change or it is no longer regulated under the 1940 Act (946-10-25-1). The entity discloses that it is an investment company applying Topic 946 (946-10-50-1), and the reasons if its status changes.

How are investments measured?

At fair value, with changes in fair value recognized in the statement of operations. The fair value framework is ASC 820, including the hierarchy and, for interests in funds, the net asset value practical expedient. See ASC 820 fair value measurement and the fair value hierarchy.

A non-investment-company parent that consolidates an investment company subsidiary generally retains the subsidiary's fair value accounting for its investments. And an investment company generally does not consolidate its controlled investees, with the exception of an investee that provides services related to the investment company's own investment activities. See ASC 810 consolidation.

What financial statements are required?

The objective in 946-205-45-1 is to present net assets, results of operations, changes in net assets and financial highlights. The package, per PwC's investment companies guide, is:

A statement of assets and liabilities or statement of net assets, with a schedule of investments. Partnerships present partners' capital, usually split between the general partner and limited partners.
A statement of operations, with management and performance fees paid or allocated to the general partner shown in it or in the statement of changes.
A statement of changes in net assets or partners' capital.
Financial highlights.
A statement of cash flows, unless exempt.

Schedule of investments

For nonregistered funds other than partnerships, the guide describes disclosure of each investment above 1% of net assets, all investments in one issuer above 1%, and at least the 50 largest. For nonregistered partnerships, a condensed schedule categorizes investments by type, country or region, and industry, with percentages of net assets, and discloses individual positions or single-issuer aggregates above 5% of net assets, with the issuer's name, shares or principal, type and fair value. A comparative schedule is presented whenever comparative statements of assets and liabilities are presented.

Cash flow statement exemption

An investment company may omit the statement of cash flows under ASC 230-10-15-4 only if all conditions are met: substantially all investments are at fair value and redeemable near term at all times (Level 1 or 2, or valued with the NAV practical expedient), average debt is little or none relative to average total assets, and a statement of changes in net assets is provided. PwC notes that in practice a cash flow statement is usually presented when debt exceeds roughly 10% of average total assets, which is a rule of thumb and not a threshold in the standard.

Financial highlights

Financial highlights are required for the most recent fiscal year, for each class held by non-managing investors. They include the ratios of net investment income and expenses to average net assets and total return, with per-share data only for unitized funds. The notes disclose the method used and whether ratios for periods under a year are annualized. Expense ratios and total return are shown before and after incentive fees or allocations. Fund-of-funds ratios reflect only the fund's own income and expenses, with disclosure that they exclude underlying fund expenses.

Illustration (illustrative). A partnership has average net assets of $50,000,000. It pays management fees and other expenses of $1,000,000 and has an incentive allocation of $750,000. The expense ratio before incentive is $1,000,000 / $50,000,000 = 2.0%. After incentive it is ($1,000,000 + $750,000) / $50,000,000 = 3.5%. Both are disclosed, along with total return before and after the incentive allocation.

What is changing: ASU 2026-03?

ASU 2026-03, issued in September 2026, amends ASC 820 for investment companies within the scope of ASC 946 on equity securities subject to contractual sale restrictions. Under EY's summary, it requires investment companies to consider contractual sale restrictions in fair value. It is effective for annual reporting periods beginning after December 15, 2027, and interim periods within them, with early adoption permitted on any date on or after issuance. See the ASU tracker.

What do auditors focus on?

These are practice points rather than requirements named in the standard:

Status memo. Obtain management's assessment against the fundamental and typical characteristics, and the fund documents that support it. A holding company with an operating subsidiary is a typical misclassification risk.
Valuation. Level 3 positions and fund-of-fund interests carry most of the risk. See AU-C 540 and using the work of a specialist.
Existence. Confirm positions with custodians, prime brokers and underlying fund administrators. See AU-C 505.
Capital accounts. Recompute allocations of income, management fees, incentive allocations and any clawback between limited and general partners.
Financial highlights. Recompute ratios and returns for each class, including timing of capital flows.
Related parties and commitments. Review side letters, capital commitments and any financial support given to investees, which is a required disclosure.
Cash flow exemption. Check that each condition is met in the period, particularly average debt.

Frequently asked questions

What makes an entity an investment company?

For an entity not regulated under the 1940 Act, all the fundamental characteristics: obtains funds from investors and provides investment management services, commits that its only substantive activities are investing for capital appreciation or investment income, and does not obtain other benefits from investees. It also usually has the typical characteristics, but missing one does not automatically disqualify it.

Does an investment company consolidate its subsidiaries?

Generally no. It measures controlled investees at fair value. The exception is an investee that provides services related to the investment company's own investment activities.

Does a private fund need a statement of cash flows?

Only if it does not meet all the conditions for the ASC 230-10-15-4 exemption, which turn on liquid fair-value investments, little or no debt, and presenting a statement of changes in net assets.

How are financial highlights presented?

For the most recent fiscal year, for each class held by non-managing investors, with ratios and total return, before and after incentive fees or allocations. Per-share data applies only to unitized funds.

When does ASU 2026-03 apply?

To investment companies, for annual periods beginning after December 15, 2027, with early adoption permitted.

Sources

FASB, ASU 2013-08, Financial Services - Investment Companies (Topic 946): Amendments to the Scope, Measurement, and Disclosure Requirements, 946-10-15-4 through 15-8, 946-10-25-1, 946-10-50-1 through 50-3, 946-10-55, 946-10-65-2 (as presented in PwC Viewpoint's full text of the ASU).
PwC Viewpoint, Investment companies guide, section 1.6, Financial reporting.
EY AccountingLink, Effective date matrix as of 30 September 2026, ASU 2026-03; KPMG, Accounting standards effective dates.
FASB, ASC 946-205-45-1; ASC 230-10-15-4. https://asc.fasb.org

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ASC 946 Investment Companies: Scope, Fair Value Accounting and Required Financial Statements