A Guide to Proper Reporting and Valuation of In-Kind ContributionsBy Joseph J. Kanjamala | March 26, 2020
In addition to financial contributions, not-for-profits (NFPs) frequently receive donations of goods and services or in-kind contributions. These donations could be in the form of a contributed service, such as free legal service, or gifts-in-kind such as a piece of furniture or pharmaceuticals. The gifts-in-kind could be tangible, as in pharmaceuticals, or intangible, such as a guarantee or below-market interest rate.
There is a common misconception among stakeholders that because in-kind contributions are free, there is no need to record them on an NFP’s financial statements. Stakeholders may argue that recording these items will merely gross-up revenue and expenses with no effect on the operating results. However, not recording these items can distort an NFP’s financial statements, understating the organization’s revenue and expenses, and does not allow for true comparison between similar organizations. As such, NFPs are required to report these contributions.
U.S. generally accepted accounting principles (US GAAP) require an NFP to report the fair value of the in-kind contribution on its financials on the date when the contribution is made known to the NFP, irrespective of the actual date of receipt. To be recognized as a contribution, the goods or services must create or enhance a nonfinancial asset and/or require a specialized skill that the contributor has and would typically need to be purchased if not provided through contribution.
However, even if these criteria are met, if the goods or services are not in a condition that allows for their use when they are received, if they are for the benefit of another organization, or if in an agency transaction it is difficult to determine their value, then the revenue and expenses recognition could be inappropriate. The value of the in-kind contribution is recorded as a contribution in the operating revenue and support section of the statement of activities and as an expense in the statement of functional expenses as a natural expense line item. If the in-kind contribution is a capitalizable item, such as real estate, then an asset account is recorded instead of expenses. In no instances can the contribution offset the expense or assets. If the donor restricts the in-kind contribution, then it should be recorded as a donor-restricted contribution.
Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 958-605 requires an NFP to value-in-kind contributions at fair value. FASB ASC 820 defines fair value and establishes a framework for the measurement of fair value. The fair value measurement assumes that the transaction to sell the asset or transfer the liability takes place either in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability.
Fair value is defined by Topic 820, Fair Value Measurement, as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.” Fair value is a market-based measurement and not an entity-specific measurement. The purpose of fair value measurement is to estimate the price, which requires assumptions (including assumptions about risk) that market participants would use. The various techniques used for fair value measurement are market, cost, and income approaches. Items such as in-kind contributions tend to follow the market approach for valuation, though there are exceptions.
RECORDING AND VALUATION OF COMMON IN-KIND CONTRIBUTION ITEMS
- Donated Auction Item
When an NFP receives an item to be sold at a gala or an auction, the NFP must record that contribution at fair value on the date on which the contribution is made known to the NFP. Later, if the item is sold at the auction at a price different from the fair value, then the NFP must recognize an adjustment to the original contribution amount recorded.
- Public Service Announcement (PSA)
Often, an NFP receives free airtime, media space or advertising on a television network, radio station, newspaper or website—commonly referred to as a public service announcement (PSA). PSAs provide future economic benefits to an NFP in the form of potential contributions, membership fees, promotion of the NFP’s mission, etc. Therefore, the fair market value of the PSA must be estimated and recorded in the NFP’s financial statements. The provider of the PSA can give a detailed listing of the PSA with the price-per-minute, which can be used for estimating the fair value.
- Free Usage of Space
When an NFP is allowed to rent a space free of charge, or at a rental rate that is below the fair rent for space, the NFP must record an in-kind contribution estimated at the fair rent or the difference between the fair rent and the below-market rent that the NFP is paying. If the lease involves multiple years, the NFP must record the net present value for the entire term of the arrangement in year one as a donor-restricted contribution and pledges receivable. The restriction would be released over the term of the lease agreement. In a multiyear lease, the fair value of the lease recorded in the books cannot exceed the fair value of the property. For example, if the total lease payments over the term of the lease equal $2 million where the fair market value of the property is $1.8 million, the contribution recorded in the first year would be limited to $1.8 million.
- Donated Professional Services
When professionals such as accountants, lawyers, doctors, carpenters, nurses, teachers and other professionals provide pro bono services to an NFP, the fair market value of such services must be estimated. This can be achieved by using the average hourly rates for such services as published by the U.S. Bureau of Labor Statistics and/or private organizations such as the Independent Sector.
- Board Member Services
When Board members of an NFP contribute their time to its governance and mission, such services are valuable but do not need to be recorded as an in-kind contribution. However, Board members frequently have highly specialized professional skills and may use these skills for projects that would normally be considered outside the scope of normal Board duties. For example, a Board member who is an attorney is engaged, pro bono, to defend the NFP in a lawsuit. The time spent by this Board member is a contributed professional service, and thus the fair value must be recorded as a contribution.
- Contribution of Land and Buildings or Other Fixed Assets
When the legal titles to land and buildings or other fixed assets are transferred to an NFP, the NFP records the fair market value of the asset with a corresponding credit to contribution without donor restriction. The fair market value is estimated through an appraisal of the asset. (Before the adoption of ASU No. 2016-14, NFPs had a choice to record the in-kind contribution of land and buildings and other fixed assets as contributions with donor restrictions and then release the donor-restricted net assets over the years when the asset was depreciated. With the adoption of ASU 2016-14, in the absence of explicit donor restrictions, NFPs would be required to use the “placed in service” approach and can no longer imply a time restriction and release it over the life of the fixed assets.)
The fair market value of donated clothing is estimated based on the cost incurred to bring the clothing to a saleable condition. An NFP may incur costs to maintain donation bins, transport the donated clothing to a central warehouse for sorting, cleaning, folding and packing, transporting the clothing to a thrift store for sale, the salary and related costs of the people involved in preparing the clothing for sale, etc. Such costs are used to arrive at the fair value of the donated clothing inventory.
- Donated Pharmaceuticals
NFPs that receive and report donated pharmaceuticals are highly monitored by the Internal Revenue Service, the attorneys general of various states and other regulatory bodies. The fair value of donated pharmaceuticals is generally estimated using prices published in professional reference materials such as Thomson Reuters “Red Book,” industry-recognized information and pricing reference guide for prescription and over-the-counter drug products in the United States. However, different pricing models exist, and organizations have to choose a model to estimate the fair value of pharmaceutical contributions. “Red Book” contains the Average Wholesale Price (AWP), Wholesale Acquisition Cost (WAC), Direct Price (DP), Suggested Retail Price (SRP) and Federal Upper Limit (FUL). AWP, WAC and FUL are the most common pricing models used by NFPs. AWP is the average price for medications offered at the wholesale level. WAC is an estimate of the manufacturer’s list price for a drug to wholesalers or direct purchasers but does not include discounts or rebates. FUL is the maximum reimbursement amount allowed for certain drugs under Medicare. Pricing under AWP is the highest, followed by WAC and FUL. There are several alliances of pharmaceutical companies and NFPs, such as Partnership for Quality Medical Donations (PQMD), Accord and others that have attempted to establish guidelines for the valuation of donated pharmaceuticals. Because the practice followed for the valuation of contributed pharmaceuticals can vary, in some cases, it has been questionable and controversial. For instance, the state of California has sued several charities over pharmaceutical valuation methodologies in which the state took the position that the principal or most advantageous market is the foreign market where the beneficiaries are, rather than the U.S. market where the pharmaceuticals are mostly transacted. The California legislature went so far as to establish their own GAAP on the valuation of contributed pharmaceuticals, which was vetoed by the Governor.
- Collection Items
Examples of collection items are pictures, antiques, stamps, coins, manuscripts, etc. that are protected, preserved and held for public exhibition, education or research or in furtherance of public service rather than financial gain. When an NFP receives an in-kind contribution of collection items, whether to record a contribution depends on the NFP’s accounting policy on collection. In general, if the accounting policy is to capitalize collections, the NFP records an asset with a corresponding credit to a contribution. However, capitalize collections, the NFP records an asset with a corresponding credit to a contribution. However, if the policy is not to capitalize on collections, then a contribution is not recorded. if the policy is not to capitalize collections, then a contribution is not recorded.
- Donated Stock
The fair value of a donated stock is recorded as a contribution on the date on which the donation is made known to the NFP at its value on that date. If there is a change in the fair value of the stock on the date on which the NFP receives the stock, the fair value originally recorded needs to be adjusted to reflect the fair value on the date of receipt. When the NFP sells the donated stock later, a gain or loss on sale would be recorded, which is the difference between the sale price and fair value already recorded. Under ASC 230-45-21A, when an NFP converts donated stock nearly immediately into cash, then the sale proceeds must be considered as an operating activity for cash flow purposes. However, if the donated stock is restricted for a long-term purpose, then the proceeds from the sale of the donated stock are considered as a financing activity for cash flow purposes.
- Bargain Purchase
A contribution may occur as part of an exchange transaction. For example, an NFP land trust compensates a resort to set aside part of its land from development. The appraised value of the land is $3 million, but the resort agrees to accept only $1 million from the NFP. That difference between $3 million and $1 million is considered a contribution.
Because of an NFP’s credit history or financial standing, it may have difficulty obtaining a loan or line of credit from a financial institution. In such a situation, the financial institution might receive a guarantee for the NFP’s loan from an unaffiliated for-profit or not-for-profit, without the NFP providing commensurate consideration. In a transaction like this, the NFP has received an intangible contribution, which is the difference between the stated interest on the loan agreement and the market interest rate that would have been charged if the NFP had entered into the loan without a guarantee. The NFP records an interest expense for the differential with a corresponding credit to contribution. There is also a conditional contribution attributable to this transaction, which is the guarantor’s promise to pay off the debt upon the NFP’s default. The NFP records a contribution if the NFP defaults on the debt and the guarantor pays off the debt. If the guarantor is a related party or company under common control, then the interest is not imputed.
- Below-Market Interest Loans
When an NFP receives interest-free loans or loans at interest below prevailing market rates, an in-kind contribution is generated and the NFP must impute interest on such loans. The value of the in-kind contribution is the difference between the stated interest rate in the loan agreement and the prevailing market interest rates, and the NFP records an interest expense with a corresponding credit to contribution. When the interest-free loan is long term, the presumption is that a portion of the long- term debt is imputed interest payable. Accordingly, in year one, the NFP records a portion of the debt as loan payable and the balance as imputed interest payable. In subsequent years, the imputed interest payable is amortized, and by the due date of the debt, the loan payable will be shown at the face value of the loan. If the interest-free loan is between a parent and a subsidy, imputing the interest is optional.
The current disclosure requirements include the nature, extent, amount and programs or activities for which the contributed services were used, and any restriction imposed by donors on the use of contributed assets. On February 10, 2020, FASB issued a proposed ASU intended to improve transparency around how NFPs present and disclose gifts-in-kind and require NFPs to have additional presentation and disclosure requirements as outlined below.
PROPOSED PRESENTATION REQUIREMENTS
Not-for-profit organizations would be required to present contributed nonfinancial assets as a separate line item in the statement of activities.
a) Disaggregate the gifts-in-kind by category.
b) For each category, provide qualitative information on whether the gifts-in-kind were or are intended to be either monetized or used during the reporting period and future periods. If used, include a description of programs in which these gifts-in-kind were or are intended to be used.
c) Description of donor restrictions on the gifts-in-kind, if any.
d) The valuation technique used to arrive at fair market value, including the principal market or most advantageous market if there is no principal market. The comment period ends on April 10, 2020. The professionals in Marks Paneth’s Nonprofit, Government & Healthcare Group will continue to monitor updates to the financial reporting of in-kind contributions to help nonprofits adapt to and comply with changing disclosure requirements.
About Joseph J. Kanjamala
Joseph J. Kanjamala, CPA, CGMA, is a Partner in the Nonprofit, Government & Healthcare Group at Marks Paneth LLP. His responsibilities in this role include designing audit strategies, supervising and training staff, liaising with clients, and providing oversight so that audits are conducted in a timely and cost-effective fashion. During his more than 20 years of public accounting experience, Mr. Kanjamala has developed deep skills in serving nonprofit organizations and has served numerous charitable organizations,... READ MORE +