AICPA Guide Chapter-by-Chapter: 6 — Split-Interest Agreements and Beneficial Interests in Trusts

AICPA guideAs a member of the task force that drove the overhaul of the recently-released AICPA Not-for-Profit Entities Audit and Accounting Guide, I am providing weekly, chapter-by-chapter summaries to help users preview the guide

The guidance in Chapter 6 is divided into two main categories based on the type of split-interest agreement:

• Pooled income funds and net income unitrusts

• Lead trusts, remainder trusts, perpetual trusts, and charitable gift annuities

The primary difference in accounting for the two categories is the characterization of the fair value of the portion due to the beneficiary as either deferred revenue for the former, or a liability under the agreement for the latter. When using the Guide, refer to the correct section and examples for the type of split-interest agreement you are working with.

Initial Recording

Assets, liabilities, and contribution revenue recognized at the inception of a split-interest agreement must be recorded at fair value when received. Fair value is measured using appropriate measurement methods, which most often incorporate the use of present-value techniques. The contribution element of the split-interest agreement should properly reflect any time or purpose restrictions.

Subsequent Accounting

The accounting for split-interest agreements depends on who controls the assets.

NFP is Trustee
When the NFP is the trustee, and/or otherwise holds the assets under a split-interest agreement, it subsequently must amortize the discount associated with the contribution and revalue its liabilities to beneficiaries based on changes in actuarial assumptions. If present value techniques initially were used to measure fair value, the discount rates used in those measurements are not adjusted. Alternatively, if the NFP makes the fair value election for subsequent measurements, all elements of the valuation, including discount rate assumptions, should be revised at each measurement date to reflect current market conditions.

If the split-interest agreement contains an embedded derivative, the derivative (at a minimum), or the entire split-interest agreement must be remeasured at fair value. Generally, a split-interest agreement contains an embedded derivative when its terms include a mixture of period-certain and life-contingent interests and/or fixed or variable payments in various combinations (FASB ASC presents several examples of combinations that do or do not constitute derivatives at ASC 958-30-55-6).

Bank or Other Fiscal Agent of the Donor is Trustee
When the NFP is not the trustee, all elements of the valuation, including discount rate assumptions, must be revised at each measurement date to reflect current market conditions.

Set Me Free—When Liabilities Under Charitable Gift Annuities Are Extinguished

Except in a few states with trust requirements, assets received by an NFP from an annuitant pursuant to a charitable gift annuity arrangement are available for immediate expenditure by the NFP. The NFP’s obligation to the annuitant are general obligations of the NFP, thus the annuitant is in the same position as other unsecured general creditors of the NFP. To assure donors, or as a matter of fiscal discipline, NFPs sometimes purchase commercial annuities to fund the required distributions to beneficiaries under their charitable gift annuities. How should they account for that?

If the beneficiary legally releases the NFP from the liability, it may offset the annuity asset and the split-interest obligation, and recognize a gain or loss on extinguishment. What if the NFP is released, but remains secondarily liable or agrees to be a guarantor? In this case, the NFP may offset, but must reduce the gain (or increase the loss) by the fair value of the guarantee.

Home Sweet Home – Life Interests in Real Estate

Suppose a donor wants to give her personal residence to her favorite charity, but wants to live in it until she dies. Such an arrangement is called a “life” or “use” interest. Under these kinds of arrangements, the NFP records the real estate asset contributed at its fair value, without regard to the life interest. It also records an obligation for the life interest at fair value, taking into consideration the fair rental value of the residence, the donor’s life expectancy, and who will pay executory costs over the term of the agreement (executory costs being things like taxes, utilities, maintenance, etc.). The difference between these two amounts is a temporarily restricted contribution that exists until expiration of the life interest (i.e., the donor’s death). If the donor restricted the contribution to endowment, the restriction would be permanent.

In subsequent periods, the life obligation is amortized based on changes in the life expectancy of the donor. A life interest is considered to be a lease; therefore it is not eligible for the fair value election and should not be adjusted to reflect changes in the rental market or the discount rate used in the initial valuation. The asset—the residence—should be remeasured in accordance with the NFPs policy for “other” investments. Typically, this would be fair value.

AICPA Financial Reporting White Paper

In addition to an extensive auditing section on split-interest agreements, Chapter 6 includes a section on measuring beneficial interests in trusts and the liabilities of split-interest agreements excerpted from the AICPA Financial Reporting White Paper, Measurement of Fair Value of Certain Transactions of Not-for-Profit Entities. The information included is extremely helpful, and those responsible for this area will be well served by reading it.

Announcing the Eide Bailly Non-Profit ResourceFULLness Award

Resourcefullness AwardMoney fuels mission. This hard reality is understood by every non-profit. Infinite demand, finite resources. How to fill the gap? As the saying goes, necessity is the mother of invention, and fortunately for our communities, our non-profits are very inventive. Non-profit professionals constantly demonstrate passion and creativity, and utilize those qualities to create amazing ways to find and sustain the revenue streams needed to fulfill their missions and continually benefit their communities.

Eide Bailly thinks these outstanding efforts deserve our recognition, encouragement and support. We want to help ensure that your non-profit has the full amount of resources needed to achieve your mission. Therefore, we have established the Eide Bailly Resourcefullness Award, with $10,000 prizes going to one standout non-profit effort each in Arizona, Colorado and Minnesota.

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AICPA Guide Chapter-by-Chapter: 5 — Contributions Received and Agency Transactions

AICPA guideAs a member of the task force that drove the overhaul of the recently-released AICPA Not-for-Profit Entities Audit and Accounting Guide, I am providing weekly, chapter-by-chapter summaries to help users preview the guide

Chapter 5 includes new sections on measuring and reporting noncash gifts, including gifts in kind; contributions of fundraising materials, informational materials, advertising, and media time or space; below market interest rate loans and bargain purchases; and naming opportunities. Additional emphasis is given to distinguishing among contributions, exchange transactions, and agency transactions.

What’s in a Name?

Naming opportunities, an incentive benefit sometimes offered to significant contributors, may be contributions, exchange transactions, or some combination of both, depending on the value of the public recognition and other rights conveyed to the donor. Factors to consider include:

• The value to the donor
• The length of time the naming benefit is provided
• Control over the name and logo use
• Other exclusive rights and privileges. (For example, exclusive naming rights for a university football stadium for a 10-year term is likely worth more than the having one’s name on a plaque in the university library.)

Agency Transactions — Not Revenue, Not Expenses

In the aftermath of investigations by the IRS and various watchdog organizations into the distribution of certain medicines to needy populations outside the U.S., the determination of whether an apparent contribution is, in fact, an agency transaction has never been more important. In these investigations, certain international nongovernmental organizations (NGOs) were accused of misreporting agency transactions as contributions received, offset by contributions made, in situations where the NGOs arranged for the delivery of medicines directly to needy populations without clearly taking title, possession, or exercising control or discretion in using or distributing the medicines along the way. These transactions, said the IRS, were nothing more than agency transactions which, while laudable, did not constitute contributions received or made by the NGOs. The IRS further alleged that even if the transactions would have qualified as activities of the NGOs involved, the valuation methods used to determine the amounts of the contributions reported were flawed, resulting in the overvaluation of both the contributions received and made.

GIK Challenges

Gifts in kind (GIK) should be recognized if the recipient entity has discretion on using or distributing the gifts, AND also has the risks and rewards of ownership. Physical possession is not a requirement of revenue recognition. GIK that can be used or sold should be measured at fair value. GIK that can’t be used or sold are not recordable.

As was evident in the IRS investigation mentioned above, valuing GIK presents several unique challenges to the recipient entity, including the following:

• There may be a lack of an active market for the items received
• Some items received are rarely bought and sold
• Some items would not otherwise be purchased or sold by the entity
• Some items are not used at the highest and best use by the entity
• Some items may have expired
• There may be geographic or market-based diversity in pricing

While fair value estimates are just that — estimates — NFPs must carefully consider and document valuations of these gifts.

Part of an NFP’s fundraising activities may include an annual gala and/or auction. Contributions of tickets, gift certificates, works of art, and merchandise to be sold at fundraising events should be recorded as contributions at fair value. Later, when sold, the original contribution amount should be adjusted for the difference between the recorded amount and the selling price. Note: the contribution amount is adjusted, thus there is no “gain” or “loss” on the eventual sale of the contributed items.

Contributed Material or Advertising

Questions as to whether contributed fundraising and informational material, as well as advertising (including media timea and space) constitute GIK or donated professional services have long abounded. The questions are important in that the recognition criteria differ depending on the answer. The Guide clarifies that these are contributed assets, not services, and should be recognized as contributions if the NFP has active involvement in determining and managing the message and use of the materials. The involvement does not need to be absolute. Advertisements or the distribution of promotional materials produced by others without any input or participation by the NFP need not be recognized.

Unlike donated professional services, recognition of contributed fundraising materials, informational material, or advertising is unaffected by whether the NFP could afford to purchase the assets, or would typically need to purchase the assets if they had not been provided by contribution. NFPs should consider the appropriate function allocation of the expense side of the contributions to the various program and supporting services categories.

Use of Campaign Proceeds to Pay Campaign Expenses

NFPs commonly earmark a portion of capital campaign proceeds to offset the costs of conducting the campaign. FinREC has clarified that such a practice is a violation of a donor’s enforceable right to have his or her contribution expended only for the purpose stipulated by the donor. In the absence of explicit donor stipulations, campaign solicitation materials may imply those purposes. Unless those materials include campaign costs as an explicit use of campaign proceeds, NFPs are precluded from using such proceeds to pay those costs. Doing so is an act of noncompliance with donor restrictions.

To avoid this prohibition, NFPs should make their intentions known by effectively communicating to all prospective donors during the solicitation process. Disclosing the policy in the notes to the financial statements is not sufficient.

AICPA Financial Reporting White Paper

In addition to an extensive auditing section geared toward the revenue recognition issues unique to NFPs, Chapter 5 includes a section on measuring unconditional promises to give cash or other financial assets excerpted from the AICPA Financial Reporting White Paper, Measurement of Fair Value of Certain Transactions of Not-for-Profit Entities. The information included is extremely helpful, and those responsible for this area will be well served by reading it.

Senate Finance Committee Identifies Tax Reform Options for

U.S. CapitolSenate Finance Committee Identifies Tax Reform Options for Exempt Organizations and Charitable Contributions

On June 13, the Senate Finance Committee released a paper describing certain tax reform options under consideration for tax-exempt organizations and charitable giving. The various options discussed “represent a non-exhaustive list of prominent tax reform options suggested by witnesses at the Committee’s 30 hearings on tax reform to date, bipartisan commissions, tax policy experts, and members of Congress.” If enacted, many of the proposals would have significant impacts on tax-exempt organizations. The Senate Finance Committee staff has indicated that, although the proposals listed are under consideration, they are not necessarily supported by a member of the Senate Finance Committee. Committee staffers have expressed an interest in discussing these options with organizations that may be affected by the proposals. The report excludes options that retain current law.

Overarching Goals and Guidelines

The report outlines the following “potential goals that could serve as guidelines for the Committee when reviewing the tax rules for exempt organizations and charitable contributions”:

  • Maximize the efficiency and effectiveness of any incentives for charitable giving that are retained or reformed
  • Consider whether the availability of tax incentives for charitable giving should be broadened to more taxpayers
  • More tightly align tax-exempt status with providing sufficient charitable benefits
  • Closely examine the relationship between political activity and tax-exempt status
  • Reconsider the extent to which tax-exempt organizations should be allowed to engage in commercial activity
  • Improve the accountability and oversight of tax-exempt organizations

Specific Concerns

Specific concerns related to the tax rules affecting tax-exempt organizations include the following:

  • Is the charitable deduction, which is an itemized deduction, fair to all taxpayers, given that the amount of the charitable deduction is proportional to a taxpayer’s income tax rate and not all taxpayers pay the same rate of tax due to the progressive tax rate structure?
  • Could alternative tax policies, such as an above-the-line deduction coupled with a floor, a refundable credit, or a government matching grant program, achieve the same overall amount of charitable giving at a lower cost to the federal government?
  • How much political activity should tax-exempt organizations be allowed to conduct, and what should organizations be required to disclose to their donors?
  • Do tax-exempt organizations provide a sufficient public benefit, particularly to the poor and underserved?
  • Do some tax-exempt organizations engage in unfair competition with for-profit businesses, which also erodes the corporate tax base and dilutes managers’ focus on the tax-exempt purpose of the organization?
  • Should more be done to prevent waste, fraud, and abuse of tax-exempt status, particularly with respect to excessive compensation and high fund-raising costs relative to amounts raised

Major Reform Proposals Being Considered by the Senate Finance Committee

  • Repeal the charitable contribution deduction
  • Fundamentally reform the charitable contribution deduction by converting it to a refundable or nonrefundable credit, a government matching grant, imposing a cap on the amount or value of the charitable deduction, imposing a maximum dollar cap on itemized deductions including the charitable deduction, allowing non-itemizers to claim the deduction, and limiting the deduction to “traditional” charities, such as churches and homeless shelters, that support the needy.
  • Attempt to increase the effect of charitable incentives on charitable giving by only allowing deductions for contributions in excess of a certain percentage of taxpayer income
  • Incrementally reform the charitable contribution deduction by simplifying how much taxpayers may deduct as a share of their income, streamlining statutory language, removing the charitable deduction from the overall limitation on itemized deductions, and allowing taxpayers to deduct charitable contributions for the previous tax year until April 15 of the following year
  • Limit deductions for noncash contributions to the lesser of the donor’s basis or fair market value, require taxpayers to recognize capital gains on transfers to charity, disallow contributions of property that are not of direct benefit to charities, limit the deductions for clothing and household items to $500, modify the rules regarding contributions of fractional interests in tangible personal property, including art, and allow enhanced deductions for inventory only in response to requests from a charity
  • Expand deductions for noncash contributions to allow taxpayers to not recognize gain on a sale of appreciated property if all proceeds are donated to charity within 60 days, make permanent enhanced deductions for the donation of food inventory by all business entities, and increase the standard mileage rate for individual automobile use by volunteers
  • Disallow deductions made to support specific commercial activities, including contributions that are a prerequisite to purchasing tickets to sporting events, contributions to support collegiate sports teams, and contributions to organizations engaged in large amounts of commercial activity
  • Modify the deduction for contributions of conservation easements by repealing the deduction, making permanent the expanded deduction, replacing the deduction with a refundable credit with a cap, eliminating the deduction for certain types of property, and strengthening the qualification requirements
  • Expand or make permanent deductions for tax-free distributions from individual retirement accounts for charitable purposes
  • Reform reporting and valuation rules by requiring charities to report gifts above a certain amount (say, $600, to improve compliance), increasing the threshold at which taxpayers are required to obtain a qualified appraisal to $10,000, and increasing reporting requirements for the contribution of inventory property

Reform Proposals Relating to Taxation of Business Activities of Nonprofits 

  • Tax all commercial activities of tax-exempt organizations
  • Revise the requirements for tax-exempt status for organizations engaged in commercial activity to disallow tax-exempt status for organizations engaged in certain business activities, impose requirements on fee-for-service organizations to provide service irrespective of pay or at a reasonable fee, clarify that commercial activities do not jeopardize tax-exempt status even if such activities provide a majority of the entity’s gross income, and reassess the treatment and requirements for hospitals and insurance providers
  • Revise the unrelated business income tax (UBIT) rules by classifying certain activities as unrelated to any charitable mission, expanding exemptions from UBIT, exempting charities that exclusively serve the poor from UBIT if income is used to fund the primary purpose, and modifying the UBIT treatment of income from debt-financed activities
  • Tighten the rules related to the conversion from tax-exempt to for-profit status by imposing a termination tax on the conversion of assets
  • Eliminate the tax-exempt status of professional sports leagues under the definition of “business leagues”

Political Activity and Lobbying of Tax-Exempt Organizations 

  • Limit political election activity of 501(c)(4), (5), and (6) organizations to a percentage of expenditures (say, 10%), require disclosure of the amount and percentage of expenditures directed at influencing elections, and require organizations supporting political activity to disclose donors
  • Change the categories of tax-exempt organizations that may engage in political activities by creating a new category for organizations engaged primarily in political activities, eliminating 501(c)(4) organizations, but allowing them to reapply for exemption under another category, requiring organizations involved in any political campaigning to be a 527 organization, and denying exemption to 501(c)(5) unions if dues are used for political campaign activities
  • Impose an excise tax on organizations that fail to report contributions or expenditures to the Federal Election Commission (FEC), require 527 organizations to register with the FEC, and deny expense deductions for election-related activity expenditures by businesses that fail to report such expenditures to the FEC
  • Reform reporting and disclosure rules by requiring organizations to notify their members of the portion of their dues used for political or lobbying activities, require any tax-exempt organization supporting political activity to disclose donors, increasing reporting thresholds for 527 organizations, and requiring 501(c)(4), (5), and (6) organizations to apply for tax-exempt status and disclose all donors
  • Clarify that payments to 501(c)(4) organizations are excluded from the gift tax
  • Expand the prohibition on 501(c)(4) organizations engaging in lobbying from receiving any federal funds, to include contracts

Broad Tax-Exempt Issues

  • Reform the taxation of private foundations by replacing the two rates of net investment income excise tax with a single rate (say, 1.40%), or relax the rule prohibiting private foundations from owning more than 20% of a for-profit corporation in certain situations
  • Reform the taxation of endowments by requiring organizations with endowments to spend or distribute certain minimum amounts each year (amount equal to at least their ten-year average compounded rate of return on their endowment minus the inflation rate minus 1 percentage point, or, alternatively, an amount equal to 5% of the endowment’s value each year)
  • Modify the rules to ensure that donor-advised funds and supporting organizations are directing resources for charitable purposes in a timely fashion by imposing a minimum payout requirement or requiring that all assets be distributed within a specified time frame
  • Limit executive compensation, replace the rebuttable presumption standard under section 4858 with a minimum due diligence requirement, and require disclosure of the compensation study
  • Reform reporting requirements by requiring organizations to make public their Forms 990-T, requiring electronic filing of all Forms 990, allowing charities with up to $1 million in gross receipts to file a simpler form than Form 990, and requiring organizations intending to claim church status to alert the Internal Revenue Service
  • Develop enforcement methods other than revocation of tax-exempt status for noncompliance

Make Your Views Known!

Tax-exempt organizations, members of management, boards of directors, donors, and grant-making organizations should consider these items and make their voices heard by the Senate Finance Committee and staffers.


If you haven’t seen it yet, I encourage you to check out In, what to me was, a surprising alliance between GuideStar, Charity Navigator and BBB Wise Giving Alliance, the new site is dedicated to exploding the myth that measuring the effectiveness of a charity by its overhead ratio is a valid measure of quality. The site’s centerpiece is a letter, signed by all three organizations’ CEOs, proclaiming that “Instead of focusing on the percentage of charity’s expenses that go to administrative and fundraising costs – commonly referred to as “overhead” – we need to focus on what really matters: impact.” Hear! Hear! As someone who has advised organizations for over a quarter of a century, I could not agree more.

While out-of-control administrative costs are a sign that the organization is being poorly, if not fraudulently, run, my experience is that we generally have the opposite problem. Not enough charities are investing what they need to in order to build an infrastructure that can support good decision making, protection of the organization’s assets and the public trust.  Often they do not even have the ability to accurately track and report financial information – including the amount of overhead actually incurred! As page two of the letter points out, there are statistics to support that what many of us know anecdotally – that a large percentage of organizations do not report their overhead expenses correctly, many by a long shot!

Not only is the information not reliable, it is irrelevant. As the letter points out “focusing on overhead without considering other critical dimensions of a charity’s financial and organizational performance can do more damage than good.” “When we focus solely or predominately on overhead…we starve charities of the freedom they need to best serve the people and communities they are trying to serve.”  In real life, I have seen time and again, organizations skimping on compensation, training, safe working conditions, antiquated computer systems and, yes, quality knowledgeable auditors – who are a key component to protecting the organization’s reputation and the public’s financial investment – only to see that same organization limp along and eventually close its doors, ultimately losing the ability to have any impact at all.

As donors, we all want to do good. Smart, effective philanthropy, is difficult. It takes a level of thought, research and understanding that demands more than a 2 second look at a single ratio. If you are not convinced, I urge you to take a look at the site and consider their case. If you are already a believer, I urge you to go to the site and learn how you can spread the word.

AICPA Guide Chapter-by-Chapter: 4 – Cash, Cash Equivalents, and Investments

As a member of the task force that drove the overhaul of the recently-released AICPA Not-for-Profit AICPA guideEntities Audit and Accounting Guide, I am providing weekly, chapter-by-chapter summaries to help users preview the guide.

Chapter 4 combines Chapters 4 (Cash and Cash Equivalents) and 8 (Investments) of the previous guide.  The Chapter does not cover:

  • investments in consolidated subsidiaries (Ch. 3),
  • investments in an entity that provides goods or services that accomplish the purpose or mission of the NFP entity or that serves an administrative purpose (Ch. 3),
  • changes in valuation and reporting investment income on split-interest agreements (Ch. 6), or
  • programmatic investments (Ch. 8).

When Cash Isn’t Cash

NFP entities may deposit funds in a related entity’s cash account under a centralized arrangement.  Common examples include deposit-and-loan, revolving fund arrangements used by many religious denominations, and local chapters of national NFP organizations. FinREC believes that the depositing entity’s cash account under such arrangement generally would not be classified as cash and cash equivalents in the depositing entity’s financial statements.  Instead, the entity would classify the deposit in the cash pool as a receivable from a related entity.

Cash held as part of an endowment fund or other investments held for long-term purposes is appropriately included in the investments line item in the Statement of Financial Position. Such treatment eliminates what can sometimes be an awkward or confusing division of investment balances between the various kinds of investments held within an investment portfolio.

Valuation of Investments in Entities Held for Investment

Chapter 4 includes expanded coverage of the valuation of investments in entities held for investment, and includes a table summarizing the guidance for 13 different relationships an NFP entity may have with investee entities, derivative arrangements, and investment pools, which is followed by several pages of discussion and examples.

Investment Expenses

FinREC has noted diversity in the types of costs that have been included as related investment expenses.  The Guide clarifies that investment expenses include, but are not limited to the costs of the following activities if conducted by the NFP (or directly on its behalf):

  • Investment advice, including advice provided by employees as well as third parties
  • Investment acquisition due diligence
  • Custodian services
  • Legal and accounting services incurred in connection with investment activities
  • Interim and year-end monitoring
  • Valuation procedures and processes

Investment expenses exclude internal fees charged by mutual funds, hedge funds, and other investment funds. Instead, those charges are considered to be a part of the investment’s return.

Fair Valuing an Interest in a Community Foundation’s Investment Pool

Some NFPs transfer funds to community foundations for investment management, seeking to benefit from the foundations’ investing expertise, size, and scale. For purposes of determining the fair value of an NFP’s interest in a community foundation’s investment pool, the appropriate unit of account is the interest in the pool itself, not the underlying investments within the pool. The pool may qualify for use of the net asset value per unit or share (NAV) as a practical expedient to measure fair value.

The Rest of It

The balance of the Chapter is devoted to an expanded discussion of endowment funds, financial statement presentation, and disclosures. It also includes expanded coverage of auditing considerations, suggested audit procedures, and incorporates AICPA Technical Practice Aid questions and answers related to determining fair values of alternative investments and the use of NAV as a practical expedient to measure fair value.