Financial Reporting

Carried Interest Accrual at Quarter-End: How a Level 3 Mark Moves the GP's Share

Fund CFOs and controllers: how the hypothetical liquidation sets accrued carry at quarter-end, a worked waterfall, and how one Level 3 mark swings GP share.

By 409.AI Team - 2026-10-07

# Carried Interest Accrual at Quarter-End: How a Level 3 Mark Moves the GP's Share

Every fund CFO knows the sentence in the limited partnership agreement that says carried interest is paid when a deal is sold, or when the fund returns capital plus a preferred return. The financial statements don't wait for that day. At each reporting date, the carry sitting in the general partner's capital account is a calculation, and its main input is a set of Level 3 marks that someone on your team signed off.

This guide is for the fund CFO, controller or administrator who closes the quarter, and for the GP who wonders why a markup on one company changed the carry line by more than 20 cents on the dollar. It covers the "as if" method that drives the accrual, a worked example with real numbers, how clawbacks behave, and what your auditor will ask for.

The rule: allocate as if the fund ended today

Many partnership agreements say carry isn't recognized until a specific event: a disposition, or the fund's liquidation. The reasoning is sensible. When investments are illiquid, interim values are subjective, and the intent is to delay the general partner's cash until gains can be measured objectively.

The financial statements still reflect it. KPMG's investment companies handbook, drawing on AICPA Technical Q&A 6910.29, says the components of net income are allocated at each reporting date as if the investment company had realized all assets and settled all liabilities at the fair values reported in the financial statements, and then allocated all gains and losses and distributed the net assets to each class consistent with the governing documents. For a partnership, the handbook adds that the carry formula is applied to unrealized gains and losses too, and the general partner class is included in the allocation ([KPMG, Investment companies handbook, Questions 4.3.40 and 4.3.60](https://kpmg.com/us/en/frv/reference-library/2025/handbook-investment-companies.html)).

Put plainly: you run the waterfall in the LPA on the reported NAV, as if the fund wound up on the last day of the quarter. Whatever the GP would receive in that wind-up is the carry the statements show in the GP's capital account. Nothing is paid out. The cash arrives later, under the terms of the LPA.

The same handbook says the allocation should happen at intervals that match the fund's policy for calculating periodic NAV. A fund that strikes NAV quarterly accrues carry quarterly.

A worked example

The numbers below are illustrative and deliberately simple. Assume a $100 million venture fund with the following terms:

Limited partners have contributed $100 million, and nothing has been distributed.
An 8% preferred return, compounded annually.
A 100% GP catch-up after the preferred return, until the GP holds 20% of cumulative profit.
An 80/20 split of everything beyond that.
A whole-fund waterfall, measured three years after the first capital call.
Management fees and fund expenses are ignored, so profit is simply the gain on the portfolio.

The preferred return is $100 million x (1.08^3 - 1), or about $26.0 million.

Scenario A: the portfolio is marked at $175 million. Cumulative profit is $75 million. The first $26.0 million goes to the LPs as the preferred return. The catch-up then runs until the GP has 20% of the profit paid so far, which takes about $6.5 million. The remaining $42.5 million splits 80/20, giving the GP another $8.5 million. The GP's hypothetical share is $15.0 million, exactly 20% of the $75 million profit.

Scenario B: the same portfolio, marked down $20 million to $155 million. Profit falls to $55 million. The preferred return is unchanged at $26.0 million and the catch-up is still $6.5 million. The remaining $22.5 million splits 80/20, so the GP gets $4.5 million more. The GP's share is $11.0 million, again 20% of profit. The $20 million markdown reduced the accrued carry by $4.0 million, which is the 20% you'd expect.

Scenario C: the portfolio is marked at $120 million. Profit is $20 million, which is less than the $26.0 million preferred return. The GP's hypothetical share is zero. The entire $15.0 million of carry from Scenario A has reversed.

Scenario C is the one to remember. The accrual isn't linear. Between a profit of $26.0 million and about $32.5 million, every extra dollar of profit goes to the GP because of the full catch-up, so a $1 million markup there can move accrued carry by $1 million. Above that range it settles at 20 cents per dollar. Below $26.0 million, no carry accrues at all. If your LPA has a partial catch-up or none, the shape changes, so build the model from your own documents.

For a CFO, the implication is that a small number of Level 3 marks near a waterfall breakpoint can move the GP's capital account sharply. Those are the marks your auditor will push on hardest, and they are worth documenting first. Our guide to [why one unobservable input puts a whole measurement in Level 3](https://www.409.ai/articles/asc-820-level-3-classification-significant-unobservable-input) explains how those inputs are classified in the first place.

Deal-by-deal and whole-fund waterfalls

The handbook notes that a manager is often entitled to its carry on a "deal-by-deal" basis, where proceeds from each sold investment are run through a defined method to decide the carry. The hypothetical liquidation applies the same logic to unrealized positions.

The difference matters at the reporting date. Under a deal-by-deal (American) waterfall, carry on early winners can be locked in while later losers sit on the books, which is why clawback provisions exist. Under a whole-fund (European) waterfall, the preferred return and return of all contributed capital come first, so carry accrues later and is usually smaller in the early years. The statement mechanics don't change. You apply your LPA's formula to the reported fair values. But the sensitivity to marks does, and so does the clawback exposure.

Clawbacks: the other side of the accrual

A clawback is an obligation on the investment manager to return previously received incentive allocations because of subsequent losses. The handbook says the effect is calculated at each reporting date using the method in the governing documents, and in most cases it reduces the general partner's capital account.

Two limits apply to how far you take it. A clawback is not recognized as a receivable in the fund's statements unless there is substantial evidence of ability and intent to pay within a reasonably short period. And in some cases a clawback can produce a negative GP capital balance, with a matching increase in LP capital. Before booking that, the handbook says the fund should consider whether the clawback is a legal obligation to return or contribute funds to the fund, and whether the general partner has the financial resources to make good on it.

The existence of a clawback should be disclosed in the financial statements, because it changes how future distributions are made ([KPMG, Question 4.3.70](https://kpmg.com/us/en/frv/reference-library/2025/handbook-investment-companies.html)). If your fund has paid out carry on early exits and is now marking the rest of the portfolio down, this is the paragraph to reread before the audit begins.

Where carry shows up in financial highlights

Carry also affects the numbers LPs compare. For a nonregistered investment partnership, the expense and net investment income ratios are calculated on expenses allocated to the LP class before any incentive allocation, with a disclosure that the ratio does not reflect the incentive allocation. An incentive structured as a fee is part of the expense ratio. An incentive allocation of profits is not presented as an expense, but all incentives are reflected in the financial highlights disclosure (ASC 946-205-50-13 and 50-14). Total return is reported before and after the incentive allocation for each reporting class taken as a whole (ASC 946-205-50-22).

If your fund meets the conditions in ASC 946-205-50-23, it reports an internal rate of return since inception, net of incentive allocations, instead. The Codification references come from the excerpts in the same KPMG handbook. For the wider reporting package around these numbers, see our walkthrough of [ASC 946 for venture funds](https://www.409.ai/articles/asc-946-investment-company-venture-fund-financial-statements).

What the auditor will ask for

A reviewer testing the carry accrual works backward from the capital account. In practice, expect requests like these:

1. The LPA waterfall language, mapped to the model, clause by clause. 2. The model run on the NAV in the draft statements, with the inputs tied to the schedule of investments. 3. A sensitivity showing which positions sit near a breakpoint. 4. The clawback calculation and the support for any decision not to record a receivable. 5. Evidence that the Level 3 marks behind it follow the written valuation policy.

That last point is why the carry line draws attention. The SEC staff's statement of 2 October 2026 on private asset fair value stresses calibration and timely information for Level 3 measurements, and our note on [what the staff statement means for NAV](https://www.409.ai/articles/sec-staff-statement-private-asset-fair-value-calibration-nav) covers it. An unsupported mark is a valuation problem, and through the waterfall it becomes a GP compensation problem as well. Keep your [valuation policy](https://www.409.ai/articles/fund-valuation-policy-asc-820-audit-sec-exam) current, and be ready to show how a mark was reached.

A practical close checklist

Before the next quarter-end, run the carry model on last quarter's NAV and confirm it reproduces the capital accounts you reported. Then flag the positions whose mark would move the fund across a waterfall breakpoint, and give those the deepest support file. Agree with the GP in advance who approves the clawback assessment. Finally, put the carry sensitivity table in the audit binder, so the conversation starts from numbers instead of a request.

Funds that use an independent valuation specialist for their Level 3 marks hand the auditor a documented, challengeable position on exactly those inputs. 409.AI prepares [ASC 820 fair value reports](https://www.409.ai/products/asc-820) for funds in that situation.

Sources

KPMG, Handbook: Investment companies, chapters 4 and 5 (Questions 4.3.40, 4.3.60 and 4.3.70, citing AICPA TQA 6910.29, and the ASC 946-205-50 excerpts): [kpmg.com](https://kpmg.com/us/en/frv/reference-library/2025/handbook-investment-companies.html)
SEC Office of the Chief Accountant and Division of Investment Management, statement on measuring and disclosing fair value of private assets, 2 October 2026: [Deloitte DART summary](https://dart.deloitte.com/USDART/home/news/all-news/2026/oct/sec-statement-considerations-measuring-and-disclosing-fair-value-of-private-assets)