Industry Insights

With the financial crisis in the not-so-distant past and continued market volatility, more not-for-profit organizations are exploring alternative investments as viable options for their portfolios. While alternative investments are attractive for their potential to profit in nearly any economic environment, they also increase exposure to risk and create additional accounting challenges.

This is a high-level overview of alternative investments and a refresher on how to record and report alternative investments within financial statements.

What are alternative investments?

The American Institute of Certified Public Accountants describes alternative investments as “assets that are not listed on any national exchanges or over-the-counter markets, or for which quoted market prices are not available from sources such as financial publications, the exchanges, or the NASDAQ.”

These investments generally do not fall under any federal or state regulator and offer greater flexibility in investment strategies than registered investment companies. Alternative investment types include:

• Common/collective trusts
• Pooled separate accounts
• Private equity funds
• Hedge funds
• Real estate investment trusts
• Funds of funds

How should alternative investments be valued?

For a not-for-profit organization, an alternative investment is generally carried at fair value. Alternative investments are considered other investments for a not-for-profit organization, and all other investments must be valued on the same basis for the entity; this could be fair value or cost, depending on the entity’s accounting policy.

Determining fair value was problematic in recent years due to the lack of available information, difficulty in formulating significant assumptions and general confusion in interpreting fair-value accounting standards. In attempting to resolve these challenges, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update 2009-12 in September 2009, permitting certain alternative investments to be valued using net asset value (NAV) per share.

The ability to use NAV is applicable only to alternative investments that don’t have a readily determinable fair value and either meet the criteria of an investment company or follow industry practice and issue financial statements using guidance consistent with the measurement principles for investment companies. Also, if it is probable that the entity will sell the investment for an amount different from its NAV, it would be precluded from using NAV to value the investment.

How should NAV-valued alternative investments be classified?

While classifying NAV-valued investments within the fair-value hierarchy does require judgment, FASB simplified the process by providing the following guidelines:

What disclosures are required for alternative investments?

Alternative investments have expanded disclosure requirements regardless of whether NAV is used beyond the disclosures required for investments in general. Additional disclosure requirements for each investment class include:

• Fair value and description of significant investment strategies
• The reporting entity’s estimate of the time period over which the underlying assets are expected to be liquidated (for investments that can never be redeemed)
• Amount of reporting entity’s unfunded commitments
• General description of terms and conditions upon which investments may be redeemed
• Circumstances under which an otherwise redeemable investment might not be redeemable
• Any other significant restriction on the ability to sell investments

Additional disclosures are required if it is probable an investment will be sold at an amount other than NAV.

For more information on recording and reporting requirements for alternative investments, contact your BKD advisor.