In the white paper Measurement of Fair Value for Certain Transactions of Not-For-Profit Entities, the AICPA’s Financial Reporting Executive Committee (FinREC) provides guidance to not-for-profits on considering risk when determining the fair value of a donor’s unconditional promise to give. Considerations may include:
Assess the donor’s ability to pay. Check published credit
ratings, financial analysis (such as cash flow and ratio analysis) or
credit reports.
Determine the donor’s commitment to honor the promise.
Consider the extent of the donor’s involvement with the
not-for-profit; the donor’s history of charitable involvement and
giving; the donor’s financial circumstances; and the donor’s personal
circumstances such as family situation, age and health.
Study risk factors that affect certain groups of donors.
Examples include economic conditions in certain geographical areas or industries.
Assess
the not-for-profit’s prior experience. Consider the extent
to which the not-for-profit has enforced previous promises to give.
Determine
whether the underlying asset is held in an irrevocable trust or
escrow. This may reduce default risk.
To account for risk, not-for-profits can use the discount rate adjustment (DRA) method or one of two expected present value (EPV) methods.
DRA discounts the projected cash flows by a risk-adjusted rate derived from rates of return for comparable assets or liabilities traded in the market. FinREC’s guidance for determining the discount rate includes:
If the donor is an individual, consider using unsecured consumer
lending rates. These generally are available from published
sources such as major financial institutions. FinREC advises using
those rates when the credit characteristics of the donor and borrowers
of unsecured debt are similar.
If the donor is a corporation, consider using the yield on its
publicly traded debt. Look to the yield on debt issued by
the corporation or by a comparable corporation. FinREC advises using
that yield when the promise to give is similar to the publicly traded
debt. If the donor is a private foundation, FinREC advises using the
yield on publicly traded debt, whether issued by the foundation, a
comparable foundation or a comparable corporation.
Whether the donor is an individual or a corporation, consider
factors specific to the promise. This information,
including the payment terms and risk of the promise, will help assess
the extent to which the promise to give is similar to publicly traded debt.
The EPV methods also account for risk:
With EPV Method 1, discount the risk-adjusted expected cash flows by
the risk-free interest rate. This rate may be indicated by
the yield to maturity on U.S. Treasurys. The risk-free interest rate
is appropriate because all risk is built into the expected cash flows.
EPV Method 1 adjusts the expected cash flows for the systematic risk
by subtracting a cash risk premium, resulting in a
certainty-equivalent cash flow. Challenges in determining an
adjustment for systematic risk can make EPV Method 1 impractical.
With EPV Method 2, discount the expected cash flows by a
risk-adjusted rate. This rate is based on the risk-free
interest rate, adjusted for general market risk by adding a risk
premium. The risk premium is necessary because not all risk is built
into the expected cash flows in EPV Method 2.
Editor’s note: This AICPA white paper discusses fair value measurement for unconditional promises to give cash or other financial assets; beneficial interests in trusts; and splitinterest agreements. It is free for AICPA members at cpa2biz.com , product code #FRC1201PDF.
—By Ken Tysiac ( ktysiac@aicpa.org ), a JofA senior editor.
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