Preparing for Your First Investment Fund Audit: A Practical Guide

What Is Changing Under the Proposed ASU?

Under the current ASC 820 framework, a contractual restriction on the sale of an equity security generally is not considered part of the security’s unit of account. As a result, the restriction does not reduce the fair value measurement of the equity security.

This approach was clarified by ASU 2022-03, which established that contractual sale restrictions are attributable to the holder rather than the equity security itself.

The FASB is now proposing a different approach specifically for investment companies. Under the proposed ASU, an investment company would be required to:

· Consider contractual sale restrictions when measuring the fair value of affected equity securities.

· Recognize the impact of the restriction when determining fair value.

· Disclose the amount of the discount attributable to contractual sale restrictions.

The proposal is intended to better align reported fair value with how market participants may value an investment that cannot be freely sold.

EXECUTIVE SUMMARY

The Financial Accounting Standards Board (FASB) issued a proposed Accounting Standards Update (ASU) on July 1, 2026, that could significantly affect how certain investment companies measure the fair value of equity securities subject to contractual sale restrictions.

The proposed guidance would create an industry-specific exception within ASC 820 for investment companies within the scope of ASC 946, requiring these investment companies to consider contractual sale restrictions when determining fair value. It would also require disclosure of the discount attributable to those restrictions.

For hedge funds, private equity funds, venture capital funds, and other investment companies, understanding these developments is important for accurate valuation, financial reporting, and audit readiness.

Why Does This Matter for Investment Funds?

The proposed change could have implications for investment fund accounting, NAV calculations, financial reporting, and investment company audits.

For example, an investment company holding pre-IPO shares subject to a lock-up period may need to consider the economic impact of that restriction when determining fair value. This could affect reported investment values and, consequently, the fund’s NAV and financial results.

Fund managers should therefore monitor these developments and evaluate how their existing valuation processes, documentation, and disclosures may be affected if the proposal is finalized.

Early consideration can also help managers identify potential changes to valuation methodologies, internal controls, financial statement disclosures, and audit support.

How Akram Team Can Help

At Akram | Assurance, Advisory & Tax, we understand the specialized accounting, audit, and tax requirements of the alternative investment industry. Our team provides tailored fund accounting, assurance, advisory, and tax services for hedge funds, private equity and venture capital funds, digital asset funds, real estate funds, family offices, and other alternative investment vehicles.

As FASB standards and guidance continue to evolve, having specialized advisers can help investment managers assess accounting implications, strengthen valuation processes, and maintain audit readiness.

Learn more about Akram’s specialized services for alternative investment funds, View Akram Services

Services | Akram & Associates Audit, tax and advisory for hedge funds, private equity, insurance dedicated funds and family offices. PCAOB registered.

Valuation Challenges in Investment Fund Audits

Valuation is often the most significant and highest-risk area of an investment fund audit. Unlike operating companies, where many assets have observable costs or market values, investment funds frequently hold securities and investments that require judgment, estimates, and assumptions to determine fair value. As a result, auditors devote substantial attention to valuation procedures.

Why Valuation Matters

For investment funds, the reported Net Asset Value (NAV) drives:

Investor subscriptions and redemptions
Management fee calculations
Performance allocations (carried interest or incentive allocations)
Financial statement accuracy
Investor confidence

A material valuation error can distort investor capital accounts and fund performance.

Common Valuation Challenges

1. Level 3 and Illiquid Investments
The most difficult valuations involve investments that do not have readily observable market prices, such as:
- Private equity investments
- Venture capital portfolio companies
- Convertible instruments
- Distressed debt
- Real estate interests
- Side pockets
In these situations, management must estimate value using models and assumptions, which introduces significant judgment and audit risk.
2. Lack of Observable Market Data
For publicly traded securities, auditors can often independently verify prices through exchanges or pricing services. For private investments, however, there may be:
- No recent transactions
- Limited comparable companies
- Infrequent third-party valuations
- Outdated financial information
The absence of market evidence makes valuation support much more challenging.
3. Subjective Assumptions
Valuation models often rely on assumptions such as:
- Revenue growth projections
- EBITDA multiples
- Discount rates
- Liquidity discounts
- Marketability discounts
- Exit timing assumptions
Small changes in these assumptions can materially impact reported values, creating significant audit scrutiny.
4. Fund-of-Funds and Alternative Investments
Funds investing in other private funds frequently rely on:
- Capital account statements
- Manager-reported NAVs
- Underlying fund financial information
Challenges arise when:
- Information is delayed
- Reporting dates differ
- Underlying fund audits are incomplete
- Estimates must be used at year-end
Auditors often perform additional procedures to assess whether these reported values are reasonable.
5. Complex Derivatives and Structured Products
Certain hedge funds invest in:
- Options
- Swaps
- Futures
- Structured notes
- Credit instruments
These investments may require specialized pricing models and independent pricing sources, increasing the complexity of the audit.
6. Consistency of Valuation Methodology
Auditors evaluate whether management applies valuation policies consistently from period to period. Red flags include:
- Changes in methodology without support
- Selective use of valuation techniques
- Inconsistent application among similar investments
- Unsupported management overrides
Consistency is critical for investor confidence and financial statement reliability.
7. Fair Value Hierarchy Disclosures
Investment funds must categorize investments within the fair value hierarchy. Auditors verify whether investments are properly classified as:
- Level 1: Quoted market prices
- Level 2: Observable inputs other than quoted prices
- Level 3: Significant unobservable inputs