Accounting Method:
For financial reporting purposes, fund managers have to choose from two different reporting frameworks: the income tax basis of accounting, as promulgated by the Internal Revenue Service ("IRS"), and the United States Generally Accepted Accounting Principles ("US GAAP"), as promulgated by the Financial Accounting Standards Board.
Tax basis is a basis of accounting that the entity uses to file its income tax return. The greatest potential benefit of preparing the partnership’s financial statements on a tax basis is time and cost savings because it eliminates the need to make GAAP-specific estimates. Under the tax basis of accounting, a partnership reports income in the year it receives cash and deducts expenses in the year it pays them out. Additionally, under the tax basis of accounting, investments are reported at cost, and changes in investment fair value are only recorded upon an exit from the investment position which is considered a taxable event.
US GAAP requires the accrual basis of accounting, which ensures proper matching of revenue and expenses within a reporting period. Under this basis of accounting, income and expenses are recorded in the period when they occur, which may be different from the period when cash is exchanged. According to US GAAP, investments are reported at fair value, which should approximate their hypothetical current exit price. The difference between the cost and the fair value of an investment is reported through an unrealized gain/(loss) adjustment and recognized in earnings during the reporting period. Additional financial statement disclosures are required to comply with the US GAAP. Reporting under US GAAP may be preferred by some lenders or equity holders and may make it easier to consolidate the partnership’s financial statements into financial statements of its parent entity if this entity uses US GAAP for financial reporting purposes.
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