# THE POSITIONS EXPRESSED IN THIS LETTER MAY HAVE BEEN MODIFIED OR RESCINDED

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## Record

- **Collection:** Agency decision
- **Document type:** Agency decision

## Text

THE POSITIONS EXPRESSED IN THIS LETTER MAY HAVE BEEN MODIFIED OR RESCINDED
ACT r eii - LlO

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

SETION l'

WASHINGTON. D.C. 20549

RULE

'i

L..ISION OF

VESTMENT MANAGEMENT

PUBLIC , /! ~' ,­

Please consult the Accounting Matters
Bibliography available at https://
www.sec.gov/investment/accountingmatters-bibiography for the staff's current
position on these matters.

 V AILAILITY I if 9 ~

November 2, 1995

Dear Chief Fincial. Officer:

, The accounting staff of the Division of Investment Management (the "Division") has
prepared ths letter to respond to questions raised by investment company registrnts and their
independent public accountats with regard to certin accounting-related matters. These
comments represeilt the views of the staff of the Division and are not necssanly those of

the

Securities and Exchange Commssion (the "Commssion"). The comments addressed in

letter apply to . fiings made by registered investment companes, including reportsths
to

Ths lettr should be read in coItunction with similar letters previously and

shareholders.

subsequently issued by the Division's accounting staff, Office of Disclosure and Review and

Offce of Insance Products. '"
IM-DCFO 1995-06

Transactions With Affiiates in a Master/Feeder Structure
.:.~.,...

In a letter addressed to Chief Fincial Officers date November 1, 1994 (the

"November 1 Lettr"), the Division expressed the position tht fuds that are compensate by
affiliates for losses

on certin of their investment holdings should account for such tranactions

as, contributions to capitaL. The staff has subsequently become aware of intances when the
master fund in a "master/feeder" strcture
received a capita contribution, but the effect of the
tranaction was not disclosed at the feeder'level. Although a feeder fund includes thefincial

statements of its master fud in its anual and semi-annual report to shaeholders, the feeer
fund's fincial statements should also reflect these capital contributions. .
If the master fud is organied as a parership, generally accepted accounting pnnciples

C'GAA") require the fmancial statements of the feeder to reflect its pro rata'portion of every
master fud traction. Income recived by, the master fund parership is considered to be
recived, pro rata, by the feeder fud contemporaneously with the receipt by the master fud.
The distrbution policy of the master 'fund doe not dictate the feeer fund's

accounting and
for
income. The feeder fund's fincial statements should contain the same presentation

by the November 1 Letter with respect to the feeder fud's pro rata benefit
received from the master fud's receipt of a capital contrbution.
disclosure

suggeste

If the master fund is organi as a corporation, classification of the masteF fud's

income in the feeder fud's fmancial statements depends upon the. distribution policies of the
master fund. Until it is distrbuted, income recived by the master fund is recorded by a feeer
fud as unrealizd. appreciation. When distrbutions are made by the master fund, it must

, 'differentiate distributions from capital gain and other sources from distributions of net
investment income. The master fund's determtion of the source of its distrbutions dictates
the accounting by the feeder. A capital contrbution to a master fund corporation wil not be
automatically recorded by a feeder fund as such. Rather, as noted above, the feeder fund wil

account for it as it would any other increase in the master fund's overall net asset value. Notes

"J

fund's fmancial statements should refer to the circumstances surrounding the

to the feeder

capital contribution received by the master fund either specifically or by cross-reference to the
corresponding note to the fmancial statements of the master fund and should indicate the feeder
fund's benefit received.
This position has been
IM-DCFO 1995-07

Accounting For Organization and Other Deferred Costs rescinded.

In a letter dated May 9, 1995, the Division stated that the Investment Company Act of
bearg certin
1 Since then, the Division has recived a number of

1940 (the "1940 Act") does not prohibit unt investment trsts ("UlTs") from
organtional and offering expenses.

questions regarding the accminting for such expenses and the appropriate period of amortiztion.
In accordance with GAA, costs' qualifying as organtion expenses should be amortizd

over the period of benefit, not to exce sixty month. Organtion expenses generaly consist
of expenses incurred to establish a company and legally equip it to engage in business.2 Such
costs may be deferred and amortiZ by all registered investment companies. For accounting
purposes, offering cost, including the

costs of registering securities with the Commsion and

the states, do not qualif as organtion costs and, accordingly, require different accounting

treatment. Offerig costs are distinguishable from organtion expenses becuse they represent
costs associated with the sale of a fund's securities. Open-end funds may defer charging
offering costs to expense for a, period not to exceed one year. Closed-end funds and UlTs

should charge offei:ing,costs to paid.,in-capital. In accordance with industr practice, closed-

end funds and UlTs may capitaiz offenng costs until the offerig period commences. For
closed-end funds, the costs should then be charged to paid-in-capital imediately. For UlTs,
such costs should be charged to paid-in capita no later than the close,of the period durig
which unts' of the trst are first sold to the public, which generally does not exce th

days. '

Since many UlTs have predetermed termintion dates, organtion expenses should
be amortized over

the shorter of the life of the trust or sixty month from the date of

commencement of operations. UlTs with trst indentures that contain provisions for mandatory

termintion of the trst if assets fall below a specified level should acclerate the amortiztion
of any remaing organtion costs when it appears probable that the trst wil termte before
has elapsed. In such intaces,the reduction of the
the sixty month

or shorter period

amortiztion period should be' considered a change in accounting 'estiate in accordace with

Accounting Principles Board Opinon No. 20 - Accounting Changes ("APB 20").3

1 Letter to Pierre de St. Phalle, Re: Unit Investment Trust Organtiona Expenses,
publicly available May 9, 1995. Specifically, the letter addresses whether a UlT ca

"bear the cost of preparg its registration statement, trst indenture and other

documents, registerig its securties with the Commission and the states, and the intial
audit of the trt." Although these expenses were referred to in the letter as

"organiational" expenses, the letter was not intended to address the accounting treatment
of these types of expenses.

2 See paragraph 8.09 of the Audit and Accounting Guide - Audits of Investmnt
the America Institute of Certified Public Accountats, with
conforming changes as of May 1, 1994.
Companies, issued by

3 Issued by the American Institute of Certified Public Accountats, July 1971.
2

\
¡

IM-DCFO 1995-08
¡\ Financial Statements of Depositors Required by Forms N-8B-2 and 8-6

In many cases, the fmancial statements of the depositor may not be critical to evaluating

and understading a UlT offering. As a result, the staff has not objected if, under certin

circumstances, a registrant omits the depositor fmacial statements required by Item 59 of Form
N-8B-2 and Instrction l(c) (as to the prospectus) of Form S-6.

Registrants have requeste clarification of the circumtaces under which the fmacial
statements of the depositor may be omitt from Form N-8B-2 and Form S-6. In addition,
registrts that include fmacial statements have asked whether they are required to be audited.
Registrants using Form N-8B-2 orS-6 generally may omit

any of' the following conditions:

unless the depositor meets

depositor fmacial statements

· The depositor has liabilties pursuant to Section 27 of the 1940 Act (associated with
a periodic

,payment plan). Periodic payment plan certficates and some inurace

products. arè subject to refund requirements under Section 27. The depositor's
fmacial statements are importt in determg the abilty of the depositor to
refund the required amounts.

· The depositor is considered the issuer of the securities whose reserves wil be
products
charge fees for mortlity and expense risks which, in part, are credited to reserves
required by state inurance statutes. The fmacial statements reflect the size of the
reserves available to cover these and other risks.
relied upon to ensure payments. Insce companes issuing varable

· The depositor has a legal obligation to maintain a sec9ndary market for the
securities. To prevent trsts from dimshig in siz during a specified period,
some depositors agree to maintain a seconda maket for the orderly tranfer of

ownership of trst units.4 ,The abilty of the depositor to continue to maintain that
market is reflected in its fmacial statements.
the issuer because of the nature of the
offering. For example, equity ownership unts in some trsts have been .sold with

· The depositor must continuously fuction as

the abilty to split

the

units into separate fmacial intrents. The separate

, differig market values attbutable to
traded' and have
their unique economic chacteristics based on their diffenng demands on the assets
of the issuer. Trading of the separate intrents usually req~ires the depositor's
intrments are separately

continuation in business. In addition, the depositor must remain continuously

involved when additional equity ownership unts are issued or the separte

intrments are reconstituted for the purose of a redemption.

4 More often, the depositor agrees only to attempt to maintain such a market but makes
no legal commitment. This is not considered a legal obligation to maintain a secondary
market.
3

If the depositor meets any of the above conditions so that fmancial statements are required,
the following procedures should be noted:

Form N-8B-2, the 1940 Act registration form used by UlTs that are currently issuing
securities, requires audited fmacial statements of the depositor. The fmacial statements
must include a balance sheet, statement of income (profit and loss) and a statement of
surplus for the depositor's most rècently completed fiscal year S as of the date of filing.
Form S-6 is used to register under the Securties Act of 1933 securities of UlTs registered

on Form N-8B-2 and also requires fmacial statements of the depositor. The form
requires the fmacial statements' to contain a balance sheet as of a date with niety
days of the date of
filing. This requirement is modified by Rule 3-01(a) of S-X (17
the

CFR §21O.3-01(a)) which permits the balance sheet to be as of a date with 135 days of
the date of fiing. The Commission, therefore, wil accpt balance sheets as ora date
withn 135 days of the date

of fiing. If

balance

the balance sheet is unaudited, an audited

sheet as of a date with one year of the date of the fiing must also be provided. The
fmancial statements 'must also include an income (profit and loss) statement for the most

recently completed 'fiscayear and for any subsequent period up though the date of the
latest balance sheet provided. The income statements must be audite though the date

of the latest audited balance sheet. 6 "

When fmancial statements are required in accordance with the policy set fort above, the

Offce of the Chief A~ountat of the Division wil stil consider inormal written requests for
omission or substitution of fmacialstatements pursuant to Rule 3-13 of S-X (17 CFR §210.3­
13).
,,.

This position has
been modified.
:r~,)-.."
There have been varing interpretations 'of the requirement to disclose fee waivers in a
fund's statement of operations.
The varing interpretations may result from current discrepancies
between the Audit and Accounting
Guide - Audits of Investmnt Companies 7 (which is considered

IM-DCFO 1995-09

Financial Statement Presentation of Fee Waivers

to encompass GAA) and Rule 6-07 of S-X.8 Although the audit guide states that voluntary
waivers need to be disclosed, it does not require volunta waivers to be stated separately in the
statement of operations. Rule 6-07.2 of SoX requires fee reductions or reimbursements by any
entity to be shown separately in the statement of operations as a negative amount or as a reduction
distinction between voluntary and involunta waivers and
of tota expenses. The rule makes no

amounts and a brief description of, such

requires a note to the fmacial statements, to include the

arrgements. When there is an apparent confict, registrants should follow the requirements of
S- X in fiings with the Commission.

S The fmancial statements of the depositor are required to be prepared in accordance with
Regulation S-X C'S-X"). Rule 3-02 of S-X (17 CFR §21O.3-02) requires a statement
of cash flows to be fied as part of the financial statements.

6 Id. The statement of cash flows must also be audited though the date of the latest
audited balance sheet.

7 Issued by the American Institute of Certified Public Accountants, with conforming
changes as.of May 1, 1994.
8 17 CFR §21O.6-07

4

., J

Compliance with Rule 18f-3.

IM-DCFO 1995-10

1

Rule 18f-3 (17 CFR §270.18f-31 - Exemption for Open-End Management Investmnt
Companies Issuing Multiple Clases of Shares,. Disclosure by Multiple Class and Master-Feeder
Fund; Clas Voting on Distribution Plans was adopted on Februar 23, 1995.9 The rule, among
other thgs, prescribes how
income and expenses must be allocated among classes. The allocation

methods selected by the fund, however, must be applied consistently from period to period.
Pargrph (c)(2) of the rule allows income, realiz and unrealiz'capital gain and losses, and
expenss not otherwise allocted to a particular class to be allocated on a settled share basis (as
defmed in the rule) for companes operating under Rule 2a-7 of the 1940 Act and for companes
declarg distrbutions of net investment income daily, provided those companes maintain the same

net asset value per share for each class.
Some registrnts have interpreted the rule to require funds electing to use the setted share
method to apply consistently such method to all components of operations (including realiz and

unealizd gain and losses). We believe use of the same method to allocate all components of

operations may result in a divergence of net asset value among classes when certin levels of
subscriptions are recived by a fud.' The staff, therefore, wil not object if funds relying on Rule
18f-3 consistently use a dual allocatíonmethod where such method would reduce the likelihood of
net asset values diverging among classes. The dual allocation method would permt the use of the
relative net assets method, for allocating reaized and unrealiz gain and losses and the setted
share method for allocat~g investment income and expenses.

IM-DCFO 1995-11

Pro Forma Financial Information for Business Combin'tions

used to register securities to be issued in a business
combintion, requires pro forma fmacial statements to be included if the,,,transaction meets the
Form N-14, the registration statement

criteria set fort in Item 14(a)(2) of the form. Recently, the Division did not object to the

exclusion of certin fmancial inormation by registrants when the registration statements fied on
Form N-14 solicited approval of the shareholders of two or more funds for proposals whereby the
funds to be acquired (the "target fundstl) were to be combined with and into another fund (the
"acquirg fund ").10

The tranactions typically are strctured so the combintion wil include any and al fuds
that obtain shareholder approval; however, approval by every taget fund is not necessary for the
merger to tae place. As a result, multiple pro forma presentation alterntives' are required,
depending on the number of taget funds.

9 Investment Company Act Release No. 20915 (February 23, 1995) (60 FR 11876 (March
2, 1995)1.

10 E.g., Jaffray Funds, Inc., Form N-14 (File No. 33-58849). The pro forma combined
schedule of total return and expense ratios provided in ths filing contained information
for four years prior to the period covered by the pro forma combinng fmancial
statements, which exceded the current requirement to provide the information, for the
two prior years, as noted below.

5

Aricle 11 of S-X govern the form and content of pro forma fmancial statements. Rule
1l-02(b)(8) of S-X (17 CFR §210.11-02(b)(8)) states lIif the transaction is strctured in such a
manner that significantly different results may occur, additional pro forma presentations shall be
made which give effect to the rage of possible results. II A strct interpretation of ths requirement

would produce full pro forma fmancial statements for each possible combintion.

The staff believes that including full pro forma fmancial statements for each potential
combination could be burdensome to the registrant and confing to shareholders. In situations
where the acquiring fund wil combine with only target funds that receive shaeholder approval,
the staff wil not object if, in lieu of providing pro forma fmancial statements for all possible

combintions of the eventu combined entity, registrants provide the following:

.

pro forma combing fmacial statements reflecting the combintion of all funds that are
involved in the proposed combintions, prepared in accordance with the requirements of
Rule 11-02 (b) and (c) of S-X (17 CFR §21O.11-02(b) and (c)) based on the assumption
that

.

the shaeholders of all taget funds wil approve the tranaction; and

a schedule reflecting pro forma

combined expense ratios and tota retu for every

possible combintion involving the taget funds and the acquiring fund. The schedule

should present tle inormation for all periods covered by the pro forma fmacial
statements rc;ferred to above and for each of the two fisca years prior to the ealiest pro

forma fincial statements presented. Appropriate adjustments should, be made where

funds have different fiscal years, different dividend payout rates, or other relevant
differences in order to provide a consistent presentation based on the actual results of the

accounting surivor in each' scenaio. The expense ratio should be calculated in the
maner set fort in Item 2 of Form N-1A, and total return should be calculated in the
maner set fort in Item 22 of Form N-IA. In addition, a headnote to the schedule should
explain the reason for presentation of the abbreviated pro forma inormation and briefly
describe, if relevant, any assumptions that were made to conform the inormation of the
various target fuds to that of the acquiring fund.

IM-DCFO 1995-12

.:,~~....~

Correction of Errors

Certin funds are not imediately recording the correction of errors in their books and
records. In cases where the correction would have an imediate effect on net asset value, some
funds have capitalized the loss and, amorted it over some arbitrar period. APB 20 prescribes
the accounting treatment'for adjustments resulting from the correction of errors. In pertinent par,

APB 20 requires the correction of errors to be recorded when identified. The staff believes that
imediate recognition of the entire amount of the error should be reflected in the statement of
operations and, if appropriate, the footnotes, regardless of the effect on net asset value.

Capitaliztion and subsequent amortiztion of error amounts are not accptable under GAA.
**************
This letter contain inormation of importnce to the company's independent public
accountat; therefore, we encourage these items to be discussed with them. Any questions on the

contents of this letter or related matters can be' addressed to Anthony S. Evangelista, James F.
Volk, Assistant Chief Accountats, or me at (202) 942-0590.

Very trly yours,

k~ ¿¿._~
Lawrence A. Friend
Chief Accountant
6

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