AICPA Whitepaper: Measurement of Fair Value for Certain Transactions of Not-for-profit Entities

The AICPA recently issued a whitepaper, Measurement of Fair Value for Certain Transactions for Not-for-profit Entities. As noted in the ‘Introduction’ section of this paper,

‘NFPs face various challenges in applying the provisions of Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 820, Fair Value Measurement, which codifies FASB Statement No.157, Fair Value Measurements. Many of these challenges result from the fact that markets do not exist for these assets and liabilities’.

This recent paper produced by the AICPA provides additional guidance for measuring fair value for:
• Unconditional promises to give cash,
• Beneficial interests in trusts, and
• Split-interest agreements.

The paper recommends methods for valuing these assets and liabilities consistent with the market approach, income approach, cost approach or all three if appropriate.

I have to be honest. The first time I attempted to read this paper, my head hurt. However, after reading and re-reading this many times and carefully, I think I can make some sense of this very important accounting topic for NFPs. As noted in the paper, please remember that this white paper is not a source of established accounting principles, as described in FASB ASC 105-10.

Here is my ‘cliff notes’ version summarizing some key points of the paper:

Unconditional Promises to Give Cash:

Suggested method for valuation – Present value (also known as the income approach). The market approach is not appropriate because no market exists. The cost approach is not feasible for financial assets.

Key inputs of a present value technique – cash flows and discount rate.

Present Value Techniques:
• DRA – risk adjustment happens in the discount rate (does not use risk free interest rate but uses risk adjusted discount rate)
• EPV Method 1 – risk adjustment happens in the probability weighted cash flows
• EPV Method 2 – risk adjustment happens in the discount rate (differs from DRA in that it uses risk free interest rate and adds risk premium)

As noted in the paper, the three PV techniques trade off the ease of determining a discount rate against the ease of determining the cash flows. FinREC observes that no one PV technique is inherently better than another for ensuring unconditional promises to give.

The difference between these PV methods and the current method for calculating present value on unconditional promises to give cash is incorporation of a risk premium. Consistent with FASB ASC 820 that states fair value has to take into consideration market participants, a calculation of fair value must consider the market participants willingness to take on the cash flow and acceptance of uncertainty in receipt of those cash flows – the consideration of the hypothetical market transaction of ‘at what price would a market participant be willing to purchase these cash flows’.

Beneficial Trusts

Perpetual Trusts:
Suggested method for valuation – Market approach

• The fair value of a perpetual trust held by a third party generally can be measured using the fair value of assets contributed to the trust, unless facts and circumstances indicate otherwise.
• If facts and circumstances indicate that the fair value of the beneficial interest differs from the fair value of the assets contributed to the trust, the income approach (PV technique) may also be utilized to measure the fair value of the beneficial interest in the trust.

Non-perpetual Trusts
Suggested method for valuation – Income approach

• The beneficial interest in the trust would be measured as the PV of the future distributions projected to be received over the expected term of the agreement, discounted at an appropriate rate.
• The discount rate should be equal to or exceed the rate of return on the trust.

Split Interest Agreements

The market approach for valuation of split interest agreements will be appropriate in some instances as there are some observable market values for certain types of split interest agreements. If the market approach is used, the market values would be considered Level 2 inputs because the observable values would be for similar but not identical instruments.

Assets and liabilities related to split-interest agreements are similar to assets and liabilities related to fixed and variable rate annuity contracts sold by insurance companies. However, there are differences that exist between the annuities offered by an insurance company compared with annuities offered by an NFP and it is important to consider the need to make adjustments to the market observable value, hence the market value will be considered a level 2 input. In terms of suggested methods for valuation of split interest agreements, FinREC concluded the following:

Split interest agreements with fixed payments
Suggested method for valuation – market approach

Split interest agreements with variable payments
Suggested method for valuation – present value/income approach

If the income approach is used to measure the fair value of interest obligations, a discount rate commensurate with the risks involved should be used.

The Bottom line is this….
– The AICPA’s whitepaper will be a great guide for those responsible for fair valuing unconditional promises to give cash, beneficial trusts and split interest agreements.
– The fair value needs to take into consideration market participants and their assumptions in terms of willingness to enter into a transaction and specifically address their willingness to assume risk (through factoring in a risk premium) and the nature of cash flows (credit risk, etc).

The whitepaper is available for free for AICPA members.


1 Response to “AICPA Whitepaper: Measurement of Fair Value for Certain Transactions of Not-for-profit Entities”

  1. December 7, 2011 at 5:16 pm

    Thanks for the post! I was not sure what split interest agreements were and the post really cleared up a couple of things, thanks!

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