AcSEC issues a statement

Participating Mortgage Loans Addressed—Finally

T he American Institute of CPAs accounting standards executive committee has issued a Statement of Position, Accounting by Participating Mortgage Loan Borrowers , which is the culmination of a project originating with the AICPA real estate committee in 1979. The SOP establishes the borrower's accounting for a participating mortgage loan in which the lender is entitled to participate in the appreciation in the market value or the results of operations of the mortgaged real estate project. Entities are required to accrete a liability for the participation feature and charge a part of that to expense every period, according to John M. Lacey, professor and Ernst & Young research fellow at California State University, Long Beach, who drafted the SOP for AcSEC. Lacey, the immediate past chairman of the AICPA real estate committee, said practice in this area has long been diverse.

During the SOP's exposure period, many comment letters said the payment to the borrower under the participation clause should be added to the value of the asset instead of charged to expense. "Some people believe there is objective evidence of the increase in the value of the asset as a consequence of the participation payment to a third party, which is based solely on the appreciation of the asset," said Lacey. "However, AcSEC decided the payment should be an expense." The SOP includes a section on AcSEC's basis for conclusions.

Compromise decision
When AcSEC voted on an earlier version of this SOP in 1992, said Lacey, the committee split evenly three ways, with each third voting for a different accounting treatment. Observers commented then that it was one of the most acrimonious debates in AcSEC history. The final conclusion, as approved by AcSEC and the Financial Accounting Standards Board in this SOP, is that the addition to the participation should be amortized over the remaining life of the loan. "So as we increase this participation liability, we take that increase and spread it over the remaining life of the loan," explained Lacey.

The SOP is effective for financial statements issued for fiscal years beginning after June 30, 1997, with earlier application encouraged. It will be published this summer.

C harities want to report most expenses as program services rather than as administrative or fundraising activities to appear favorably to the public and attract potential donors. Publications often rate charities based on the percentage of money spent on fundraising, and state regulators are concerned as well.

Gregory B. Capin, chairman of the NPO committee, said some charities will be unhappy with the new SOP. He suggested that CPAs be proactive in advising their clients about the rules to avoid surprises and to take advantage of planning opportunities. "CPAs and the charities' accounting staffs should be involved early in planning or reviewing activities that include fundraising and are intended to further a program or public education purpose. This will help management understand the accounting implications at an early stage rather than after the fact, when nothing can be changed. It also will minimize surprises and contentious accounting issues during an audit."

Capin said that the new statement is much clearer than SOP 87-2 in applying the criteria of purpose, audience and content, and it makes it explicitly clear that talking about the needs and causes the charity serves is in support of fundraising, not program and public education activities-unless there is a motivation to an action other than giving.

"For example, if a charity discusses the needs and plight of the homeless and appeals for gifts to provide meals and shelter or for volunteers to serve at the shelter (which is defined as fundraising by FASB Statement no. 117, Financial Statements of Not-for-Profit Organizations , and the AICPA not-for-profit guide), all costs would be fundraising under the new SOP. However, if the presentation includes actions people can take other than making contributions, some costs may be able to be allocated to public education. All criteria would have to be met and the actions substantive, such as petitioning the city council to provide more funding to local shelters and contacting businesses and houses of worship to establish food collection points."

Capin advises charities to involve their CPAs at an early stage to avoid undesirable results in annual reports and audited financial statements. "In some cases, it may be advisable for a charity to consider conducting any program or public education component separately from fundraising rather than as a joint activity. The key is to consult CPAs during the planning stages."