"Accrual method" vs. "Final charge" for management fees
There is a category of profit/loss items that are distributed proportionately among the partners according to what are called their "allocation percentages". Examples of these proportionately shared P/L items are realized gains & losses, unrealized gains & losses, dividends & interest received or accrued, and margin interest paid.
There is another category of expense-type items that are NOT shared proportionately by the partners; rather they are selectively distributed. The primary example of these selectively borne items is the assessment of the management fee levied by the general partner. Affiliated persons of the general partner are often not assessed a management fee (because of tax considerations beyond the scope of this document).
Charges that are borne by some partners but not others cannot be treated as P/L items in the same fashion as e.g. unrealized gains (which by construction will be distributed proportionately). Instead, these selective charges are treated as direct debits to the equity capital account of each partner who bears them.
In debiting a partner's capital account for a management fee, two accounting methods can be employed.
The first method is known as the "accrual method". In the accrual method, a partner's capital account is debited for management fees due, and a "management fee payable" account is credited. However, the partner's allocation percentage (which controls the partner's allocation of proportionately distributed profits & losses) remains unchanged when the management fee is accrued. If we think of the allocation percentage as the sole asset owned by the partner, then by analogy the accrual method is like a mini-recap: assets remain unchanged, but debt/equity increases. The paying partner retains the rights to the P&L... a tiny bit of leverage.
The second method is known as the "final charge". In the final charge method a partner's management fee payable account is debited, and the allocation percentage is reduced by that amount. Continuing the analogy above, part of the partner's assets are sold to pay off the management fee liability, and the partner no longer has those assets working for him; the profit/loss on that piece is forfeited and is redistributed among the other partners.
These two methods - the accrual method and the final charge - are not mutually exclusive. They are employed in tandem. The management fees are accrued each period (break period or quarter or what have you) according to the accrual method. With the passage of time, the allocation percentages of partners who pay management fees deviate more & more from the equity of the underlying capital account... they owe more & more. Every so often, the leverage is wiped out (i.e. the allocation percentage is "trued down" to equal the capital percentage) by taking a final charge.
For our own uses we decided to accrue the management fee every quarter, and take a final charge to allocations every year.
There is another category of expense-type items that are NOT shared proportionately by the partners; rather they are selectively distributed. The primary example of these selectively borne items is the assessment of the management fee levied by the general partner. Affiliated persons of the general partner are often not assessed a management fee (because of tax considerations beyond the scope of this document).
Charges that are borne by some partners but not others cannot be treated as P/L items in the same fashion as e.g. unrealized gains (which by construction will be distributed proportionately). Instead, these selective charges are treated as direct debits to the equity capital account of each partner who bears them.
In debiting a partner's capital account for a management fee, two accounting methods can be employed.
The first method is known as the "accrual method". In the accrual method, a partner's capital account is debited for management fees due, and a "management fee payable" account is credited. However, the partner's allocation percentage (which controls the partner's allocation of proportionately distributed profits & losses) remains unchanged when the management fee is accrued. If we think of the allocation percentage as the sole asset owned by the partner, then by analogy the accrual method is like a mini-recap: assets remain unchanged, but debt/equity increases. The paying partner retains the rights to the P&L... a tiny bit of leverage.
The second method is known as the "final charge". In the final charge method a partner's management fee payable account is debited, and the allocation percentage is reduced by that amount. Continuing the analogy above, part of the partner's assets are sold to pay off the management fee liability, and the partner no longer has those assets working for him; the profit/loss on that piece is forfeited and is redistributed among the other partners.
These two methods - the accrual method and the final charge - are not mutually exclusive. They are employed in tandem. The management fees are accrued each period (break period or quarter or what have you) according to the accrual method. With the passage of time, the allocation percentages of partners who pay management fees deviate more & more from the equity of the underlying capital account... they owe more & more. Every so often, the leverage is wiped out (i.e. the allocation percentage is "trued down" to equal the capital percentage) by taking a final charge.
For our own uses we decided to accrue the management fee every quarter, and take a final charge to allocations every year.
posted by Bobby at 2:43 PM
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