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.

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