Since the standards for recognizing contributions at their fair value were issued in 1993, NFPs have been challenged to measure the value of the myriad contributions they receive. This controversial area is once again being addressed by watchdog agencies and state attorneys general and, thus, is one that NFPs should navigate with care.
Determining the fair value of cash and marketable securities is typically straightforward, but for most nonfinancial assets (for example, food, supplies, used clothing and household items, intangibles, medical equipment, and pharmaceuticals), the valuation process is less clear.
In 2006, FASB issued its fair value measurement standard (FASB Statement No. 157, later codified as FASB Accounting Standards Codification [ASC] 820, Fair Value Measurement), which was broadly written to address both financial and nonfinancial assets. The standard defined fair value and provided a principles-based approach for measuring fair value. Although there are examples in the standard that illustrate the application of its basic principles, including application to various nonfinancial assets, the standard did not and could not exhaustively illustrate application to all types of assets contributed to NFPs.
Accurate valuation and revenue recognition of nonfinancial gifts (commonly referred to as gifts-in-kind, or GIK) are a challenge, particularly for GIK that are used by the NFP for program activities and not subsequently sold in the marketplace. (Sales data provides valuation evidence for items sold, so those generally are not problematic transactions.) The basic guiding principles for determining the fair value of GIK have not changed over the years. However, NFPs’ understanding of the characteristics and issues surrounding GIK has matured, best practices have developed for addressing issues, and the markets transacting in GIK are evolving.
Some of the issues and challenges surrounding nonfinancial GIK assets include the following:
GIK is an important part of the mission for many charities; however, some watchdog agencies, donors, and regulators can be skeptical of transactions involving GIK. Because the fair values of GIK are estimates and GIK transactions result in revenues and expenses being recorded in the financial statements that do not result from cash receipts and cash payments, those users may be wary of the information in the financial statements and the ratios computed using that information. Reporting the revenues and expenses resulting from GIK demonstrates how much an NFP depends on noncash contributions to perform its mission. When used properly, GIK can greatly extend the cash resources of NFPs because the GIK often consist of goods and services the organizations would otherwise have to purchase.
GIK use is often subject to donor restrictions and sometimes legal restrictions. An NFP needs to be thorough in understanding which restrictions are characteristics of the donated assets (and, thus, are restrictions that affect valuation) and which are donor-imposed use restrictions (which are entity restrictions that affect classification of net assets but don’t affect measurements of fair value). For example, when pharmaceuticals are sourced in foreign countries (and, thus, unable to be sold in the United States because the pharmaceuticals do not meet U.S. Food and Drug Administration standards), it is a best practice to assume a rebuttable presumption that international market prices should be used to determine fair value. The inability of the pharmaceutical to be sold in the U.S. marketplace is an asset characteristic to be considered in valuing the GIK. However, a donor-imposed restriction to use the pharmaceutical in Africa is a donor-imposed use restriction, which affects the classification of the contribution revenue but not the valuation of the GIK.
In some cases, an NFP makes a payment in association with obtaining an asset, and it needs to determine whether the transaction is a purchase (an exchange of equal values) or is, in part, a contribution (a nominal payment for GIK with substantially higher value). For example, a corporation provides a parcel of land to an NFP with a fair value of $100,000, but it requests that 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.
Identifying publicly available inputs to fair value measurement can be challenging. Some GIK are items that the NFP would not otherwise buy and, therefore, the NFP may be unfamiliar with the markets for those items. Some GIK items do not trade in active markets that publish pricing information. An NFP may sell GIK items (and, therefore, have exit prices), but if the NFP’s sales do not reflect the item’s highest and best use, the sales prices are not fair value. Despite the challenges of valuation, NFPs should make a good faith estimate of fair value by searching for transaction data for actual transactions in active markets they can access. For example, for pharmaceuticals, state Medicaid and federal Medicare prices represent transaction prices in active markets. If the pharmaceuticals are salable in the United States, NFPs could use one of these actual market prices for an estimate of the fair value. However, if the pharmaceutical is only salable internationally, prices in the International Medical Products Price Guides, which also represent transaction prices in active markets, could be used for an estimate of the fair value.
NFPs strategically partner with organizations to provide necessary GIK to beneficiaries who would not otherwise have access, and GIK is increasingly a component of a corporation’s charitable giving program. In some of these partnerships, it can be challenging to determine if the NFP is acting as an agent (either for the donor or the partner) or if the GIK received is actually a contribution received.
NFPs need to refresh their understanding and consider new market data on a regular basis. This likely will result in changes in valuations of similar items over time, as it should, because markets and values aren’t static. NFPs have the responsibility to ensure that fair value knowledge is regularly updated. This means not only updating values but also updating the understanding of markets. Independent auditors will assess management’s GIK valuation methodology, but the burden of support for all fair value determinations lies with management.
What Does a “Fair Value Measurement” Mean When It Comes to GIK Contributions?
Fair value is defined 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” (FASB ASC Glossary). However, an NFP receives these assets as a contribution, not as a market participant. Thus, the NFP has a hypothetical consideration: Which market would it use if it were to sell the goods? Would the goods be sold in an exit market as a retailer, wholesaler, or manufacturer, or would they be sold in some other market? What if the NFP does not have access to sell the goods in any market?
Certain GIK may not have a readily determinable marketplace, but typically, they have a base utility that is marketable to someone. NFPs should consider that base utility when determining market values for GIK.
Consideration of Legal Restrictions
Legal restrictions fall into one of two buckets—those that affect the entity or those that affect the asset. Legal restrictions that affect only the NFP do not affect the underlying asset’s fair value because a hypothetical buyer would not consider the restrictions in a purchase decision because that buyer’s use of the asset would not be affected by the restriction imposed on the entity.
On the other hand, legal restrictions that could limit a buyer’s use of the GIK may affect the assets’ fair value. For example, a land conservation easement that limits the use of a piece of land would be considered by a hypothetical buyer and may affect the land’s value. An NFP may never actually sell the GIK, but a hypothetical sale should be considered in determining fair value. An NFP needs to identify any legal restrictions on the GIK and determine if they would affect a hypothetical buyer’s use and, thus, the fair value measure.
The following four areas addressed in FASB ASC 820 are particularly challenging when it comes to determining fair value of GIK:
1. Market participants.
MNFPs often distribute GIK free of charge or for a nominal fee to beneficiaries who can use the goods but generally do not have access to them. These beneficiaries are not market participants. In addition, nominal fees charged are not prices for the GIK’s highest and best use; they are prices that reflect the NFP’s mission objectives. Market participants are entities who would transact for the goods and are able to buy the product at its market price. Because of the nature of GIK, a hypothetical market participant scenario may need to be developed to identify potential market participants. These may include other NFPs, governmental agencies, or other entities (including for-profit entities), depending on the goods involved.
2. The principal (or most advantageous) market.
Fair value should be determined using inputs from the principal market (defined as the market with the greatest volume and level of activity for the asset), or if there is no principal market, from the most advantageous market (defined as the market that maximizes the amount that would be received to sell the asset).
Certain GIK, such as pharmaceuticals, clothing, toys, and so on, are regularly obtained subject to entity restrictions prohibiting the NFPs from selling the assets. In those cases, there is no market in which the reporting entity could sell the asset. FASB ASC 820-10-35-6B states that although a reporting entity must be able to access the market, it does not need to be able to sell the particular asset or transfer the particular liability on the measurement date to be able to measure fair value on the basis of the price in that market.
Further, the Financial Reporting Executive Committee (FinREC) believes that limitations imposed by IRC Section 170(e)(3) (which provides a larger deduction to the donor if the NFP agrees to use the GIK, rather than sell them), as well as donor-imposed restrictions limiting the geographic area in which GIK may be distributed, are restrictions specific to the entity. Because those restrictions are not a characteristic of the asset that would transfer to market participants, such restrictions would not be considered in pricing the asset.
3. Inputs to valuation techniques.
Once the proper marketplace is identified, it is necessary to identify a source for exit prices in that market. Locating sources is not always easy or inexpensive. Accounting standards provide only broad, general guidance, and many NFPs struggle to find useful guidelines to help determine the value of donated assets. Sometimes, inputs can be found, but the prices may need to be adjusted for differences between the source item and the GIK or for differences between the source price (which could be a list price) and an exit price. The AICPA Audit and Accounting Guide Not-for-Profit Entities provides the following examples.
If GIK are received in wholesale quantity but only retail values are readily available to use as inputs to fair value, then a wholesale discount generally would be applied. Similarly, if the GIK have earlier expiration dates than those of products typically sold in the marketplace or if technological advances have made the GIK less desirable than similar items in the marketplace, a discount should be applied. Whenever GIK differ from the item observed in the marketplace transaction, the NFP should consider whether an adjustment is needed to determine fair value.
For some types of GIK, a range of valuation inputs are available, which can result in dramatically different valuations, especially if observed inputs have not been properly adjusted. Small and mid-sized NFPs may not have the resources to access that type of market data. Even NFPs with the resources to purchase the data have discovered that identifying the relevant variables and making the necessary adjustments can be very complicated. Management should consider the potential materiality of the GIK and determine how best to use its limited resources to find inputs.
4. Use of hypothetical markets.
Due to the constraints outlined in the three preceding items, the markets and transactions used for valuation are often hypothetical; yet, this remains the most likely source for determining fair value of certain GIK. All entities that could have access to the hypothetical market should be considered, including for-profit entities, and the value determined in such a hypothetical market would be derived from the hypothetical market participant’s perspective as opposed to the reporting entity’s perspective.
In other words, if the NFP does not have the ability to sell in any market, FASB ASC 820-10-35-6C states
Even when there is no observable market to provide pricing information about the sale of an asset or the transfer of a liability at the measurement date, a fair value measurement shall assume that a transaction takes place at that date, considered from the perspective of a market participant that holds the asset or owes the liability. That assumed transaction establishes a basis for estimating the price to sell the asset or to transfer the liability.
Therefore, the NFP should construct an assumed transaction in a hypothetical or “most likely” market based on its own assumptions about what participants in that market would consider in transacting a sale of the asset. It is reasonable to conclude that activity in inaccessible known markets may be considered in developing the inputs that would be used in a hypothetical market if the reporting entity does not have access to any known or observable markets.
Flowchart for GIK of Nonfinancial Assets
This flowchart describes considerations for the valuation of GIK of nonfinancial assets.
For GIK received, NFPs can look at the characteristics of the GIK, as well as assumed transactions, to determine appropriate fair values. Though the valuation and contribution considerations are complex, an NFP would be well-served to develop and document a consistent, reasonable process to assess and record the fair value of GIK in accordance with U.S. GAAP. Significant judgment may be involved with GIK. Management’s documentation of its assessments and all the GAAP considerations is key.
Readers can obtain additional fair value information from the following sources:
FASB ASC 820
AICPA Audit and Accounting Guide Not-for-Profit Entities, chapter 5, paragraphs .130–.146, “Fair Value Measurement of Gifts-in-Kind”
Auditors can obtain information on auditing fair value accounting estimates from AU-C section 540, Auditing Accounting Estimates, Including Fair Value Accounting Estimates, and Related Disclosures.
Standards developed and published by Accord Network (formerly AERDO) could assist NFPs and their auditors. These standards offer best practices and additional guidance for NFPs in applying GAAP and IRS rules for GIK acceptance, accounting, and reporting. Note that although they have been developed with every effort to follow GAAP, Accord’s GIK standards are nonauthoritative under FASB ASC.
View this resource for information on FASB ASU 2020-07, Presentation and Disclosures by Not-for-Profit Entities for Contributed Nonfinancial Assets, including sample disclosures.
Source: This resource was adapted from the AICPA Not-for-Profit Industry Developments – Audit Risk Alert, 2018 Edition. © 2018, AICPA. This publication addresses the latest issues and developments affecting auditing and accounting for not-for-profit entities. For more information or to purchase the Alert, please visit the AICPA Store.