A number of investigative articles have been written by the media and charity watchdog agencies questioning the valuation of gift-in-kind (GIK) contributions received by not-for-profit entities (NFPs). These articles identify various approaches to valuing GIKs, focusing on the large disparities between conclusions reached by NFPs, and questioning the application of U.S. GAAP to GIKs.
Since the implementation of FASB Statement No. 157, Fair Value Measurements, issued in 2006 and now codified as FASB ASC Topic 820, Fair Value Measurement, NFPs have been challenged with how the standards and related guidance affect the valuation of GIK contributions. The valuation of pharmaceutical donations to charities has created significant scrutiny and controversy, but practices and policies for valuing GIKs in many other circumstances also should be reviewed.
GIKs are a critical focus area for many NFPs. Properly used, a GIK can enhance programming with needed goods. Improper valuation of GIK donations can lead NFPs to report inflated efficiency in the use of donor funds, particularly when compared to groups that accept only cash contributions. This can be a disservice to users of NFP financial statements, particularly potential donors who are eager for a high percentage of the resources they contribute to go to people who need them and are served by the NFP. Accepting a GIK may result in various unintended consequences if appropriate programming and accounting practices are not followed. Acceptance of a GIK requires consideration of alignment with mission strategies and a clear understanding of accounting requirements. Although different facts and circumstances may lead to different accounting results, NFPs can find common ground for GIK valuation and avoid the pitfalls by focusing on key valuation considerations.
This article focuses on common misunderstandings around GIK valuation and contributions, and offers NFP management suggestions for GIK accounting policies and practices.
Is fair value the appropriate measure? Before digging into specific GIK valuation nuances, a review of basic considerations is necessary. Are NFPs required to use fair value for GIK contributions? The short answer is “yes.” ASC Topic 820’s definition of fair value is currently applicable to contributions received by NFPs, including GIKs. That definition leads charities to use fair value, not the most conservative value, or an aggressive value. Fair value is defined in ASC Topic 820 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.”
Because valuation is difficult and includes professional judgment, and any donated value affects charity efficiency ratings, some watchdog agencies suggest that a GIK should be recorded at the most conservative or no value. Valuing a GIK in this manner, however, would not be a proper application of U.S. GAAP. Typically, a GIK has a base utility or use, and that utility is marketable to a willing buyer. This utility is noted in ASC Paragraph 958-605-25-5 as “future economic benefit or service potential,” and although it may be difficult to value some forms of GIKs, this difficulty alone should not change the conclusion about recognizing the contribution at fair value.
Navigate an NFP’s limited market experience. Knowing that GIKs should be recognized at fair value is just the beginning of the process. The first step is to identify the principal exit market for the GIK. This may prove difficult because an NFP does not often accept a GIK with the intent to sell it. Essentially, that puts the NFP in a position where it has no prior transactions or market experience to draw upon as a resource for fair value inputs.
Distinguish between principal market and distribution market. Often NFPs distribute goods to beneficiaries who have no means to pay for those goods. This does not necessarily mean the product has no value. Topic 820 defines the principal market as “the market in which the reporting entity would sell the asset or transfer the liability with the greatest volume and level of activity for the asset or liability.” Therefore, the location in which the goods are distributed may have no bearing on the principal market identified for accounting purposes.
For example, an NFP receives medical supplies in the United States and distributes them in accordance with its charitable mission to beneficiaries in Kenya who have no means to pay for the supplies. If the medical supplies would be sold in the United States at the greatest volume, and there are no other asset restrictions to consider, then the United States may be considered the principal market for valuation purposes. The fact that the goods were distributed in Kenya does not necessarily mean that the Kenya market is the principal market.
Consider legal restrictions. Legal restrictions may affect the determination of market participants and, as a result, pricing inputs. Asset restrictions (as opposed to entity restrictions) that limit the legal sale of a GIK to certain markets may affect the determination of the principal market. For example, a land conservation easement that limits the use of the land is a legal restriction specific to the land. And in the case of a pharmaceutical GIK, legal sale restrictions are imposed by the U.S. Food and Drug Administration and other international governmental bodies. Because these legal asset restrictions would be considered by a market participant buyer, an NFP should also consider their effect. An NFP may never actually sell the GIK, but a hypothetical sale should be considered for purposes of determining fair value. Regardless of whether actual sales by others or hypothetical sales are drawn upon for inputs, an NFP needs to identify any legal restrictions on the GIK. Based upon those data, the NFP should determine which exit markets, whether inside or outside the United States, are applicable to its circumstances and then seek pricing inputs in those markets.
Donor markets don’t equal NFP markets. When determining GIK valuations, keep in mind that donor markets and, therefore, donor-provided values may not relate to the principal exit market of the recipient NFP. Furthermore, donor tax values are not equivalent to fair value under U.S. GAAP. The NFP must have access to the market on the measurement date. While the donor’s market placement (e.g., whether the donor is a manufacturer, a wholesaler, or a retailer) may influence the donor’s valuation, that market placement may not represent the NFP’s principal market, and it may not be a market the NFP can access. Because GIK valuations must be derived from the principal exit market from the perspective of the NFP receiving the goods, any inputs that consider a different exit market may need an adjustment in order to target the NFP’s principal market.
When exchanging, presume purchase. Because the fair value of a GIK is determined when it is contributed to an NFP, it is important to determine when a contribution occurs. One challenging situation for NFPs to evaluate is a bargain purchase or inherent contribution. These situations are more challenging because their determinations are associated with the value of the assets. In the normal course of business, NFPs may purchase goods and services (reciprocal exchange), receive GIKs (nonreciprocal contribution), or both. Transactions that are in part an exchange and in part a contribution may be a bargain purchase if they include “inherent contributions.”
The FASB ASC glossary defines an inherent contribution as “a contribution that results if an entity voluntarily transfers assets … in exchange for either no assets or for assets of substantially lower value, and unstated rights or privileges of a commensurate value are not involved.” In most transactions, a fee exchanged reflects a purchase of goods, i.e., a nonreciprocal exchange transaction.
Exceptions arise if the fee exchanged is substantially less than the fair value of the goods received. For example, a corporation provides a parcel of land to an NFP with a fair value of $100,000, but it requests the NFP provide $10,000 in exchange for the land. The transaction has an inherent contribution because the nominal fee paid is substantially less than the value of the property. The NFP would recognize a $90,000 contribution in this case. If, however, the NFP provided $90,000 in exchange for the land, the fee paid would not be substantially less than the fair value of the property, and the NFP would not recognize a contribution.
A best practice for an NFP may be to have a policy with a rebuttable presumption that such exchange transactions are reciprocal transactions or “purchases.” Any indication of a bargain purchase or an inherent contribution when a fee is exchanged should be examined, and the NFP should document any exceptions that overcome the purchase presumption.
MANAGEMENT CONSIDERATIONS: HOW SHOULD AN NFP RESPOND TO THESE ISSUES?
Consider whether to accept a GIK. A GIK can have inherent use restrictions because of the nature of the goods. A GIK accepted by an NFP should be related to the basic mission and purposes of the NFP and be appropriate for the situation and context for which it will be used. An NFP should have a policy for assessing a GIK prior to accepting it and also needs to exercise discretion regarding what goods to accept based on a programmatic needs assessment. Because, in many situations, using the GIK is the NFP’s primary purpose and valuing the GIK is a necessity resulting from the contribution, policies for GIK accounting sometimes get overlooked because of the focus on GIK programming. An NFP should consider how it will navigate the technical complexities of a valuation before accepting a GIK.
Get equipped. Staff responsible for valuations need to understand the products received, the donor’s intent for the GIK, the market participants who would buy the goods received or similar goods, and the valuation methodologies applicable to the GIK. Gaining this understanding is sometimes neglected, but collecting this knowledge serves an organization well by enabling a consistent approach and helping ensure compliance with U.S. GAAP.
An organization’s management should be aware of issues that would materially affect the fair value of a GIK. Management should document its independent judgment on material issues, including an assessment of risks and facts to support its conclusions. This has the added benefit of equipping management to clearly articulate alternate views and support the NFP’s conclusions. Independent auditors will assess the methodology used to value the GIK, but the burden of supporting the NFP’s practice and the GIK’s reported value, as with all of the NFP’s fair value issues, rests with management, not the auditors.
Don’t give up. Recent watchdog and media attention has focused on the valuation of pharmaceutical GIKs because pharmaceutical contributions are often material to NFPs’ operations and NFPs have taken different approaches to valuing these GIKs. Historically, pricing guides containing a variety of pharmaceutical values, such as Red Book: Pharmacy’s Fundamental Reference, were commonly used to value this type of GIK. As a result of the new definition of fair value in ASC Topic 820, many NFPs have moved away from using this data. Unfortunately, no clear alternative has surfaced.
Market data for pharmaceuticals are closely guarded, and user-friendly data are not readily available to the public. Consequently, charities have adopted a number of methodologies, which have led to varying results. The same difficulties are true for other noncash donations such as environmental assets, medical equipment, and thinly traded securities. Despite these challenges, NFPs need to continue to research values to find the best sources of information and pricing inputs, and document their reasoning and conclusions.
Know your resources. Management may use resources such as publications, auditors, peers, valuation experts, and industry standards to keep informed about current risks and trends in valuing GIKs. Several industry groups provide standards for members that are also available to the public, including nonauthoritative resources. Three well-known examples are the Accord GIK Standards (available at accordnetwork.org/gik), the InterAction PVO Standards (available at tinyurl.com/pttzqv2), and the AICPA Audit & Accounting Guide, Not-for-Profit Entities (available at cpa2biz.com).
Consider the costs vs. the benefits. Management’s chosen methodology will have varying levels of effort. Consider whether those methodologies with incremental effort provide an enhanced benefit.
DEVELOP CONSISTENT PROCESSES
An NFP is responsible for the information contained in its financial statements. Issues such as the applicable principal markets and the effect of nominal fees associated with a GIK require NFPs to scrutinize their GIK practices to ensure the proper application of U.S. GAAP. While the valuation and contribution considerations are complex, an organization’s management would be well-served to develop a consistent, reasonable process to assess and record the fair value of GIKs in accordance with U.S. GAAP, and to document the approach. Significant judgment may be involved with GIK accounting. Management’s documentation of its assessments and conclusions is key. Get equipped and face the issues head-on.
Not-for-profit entities (NFPs) should review their practices and policies for valuations of gifts-in-kind (GIKs), as reports of large disparities in GIK valuations have led to controversy in the sector.
NFPs should carefully consider whether to accept a GIK. Any GIK accepted should be related to the NFP’s mission, and the NFP should have policies in place to assess a GIK before accepting it. Staff required to value GIKs should be properly equipped for the task.
Despite the challenges presented, it is possible for NFPs to find common ground for GIK valuation. Focusing on key valuation considerations can help NFPs avoid the pitfalls.
A GIK should be measured at fair value, and the first step is to identify the principal exit market. The effect of legal restrictions should be considered, and it is important to remember that donor markets may not be the same as exit markets; donor-provided values may not be relevant.
An NFP may want to have a policy with a rebuttable presumption that transactions with an exchange are reciprocal transactions or “purchases.” Any indication of a bargain purchase or an inherent contribution when a fee is exchanged should be examined, and the NFP should document exceptions that overcome the purchase presumption.
NFPs need to find reliable sources of information and pricing inputs even though they may be difficult to locate. Resources include publications, auditors, peers, valuation experts, and industry standards; industry groups provide standards that are available to the public.
Jennifer Brenner (email@example.com) is associate director for financial accounting and operations for World Vision, a relief, development, and advocacy organization that works to fight poverty.
To comment on this article or to suggest an idea for another article, contact Ken Tysiac, senior editor, at firstname.lastname@example.org or 919-402-2112.
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