Understanding FASB Valuations and Their Role in Your Financials
The poet Oscar Wilde noted that “consistency is the last refuge of the unimaginative.” He would appreciate the imagination required when valuing charitable contributions. Previously, we’ve discussed the range of approaches to contribution valuation:
- Deduction – The value of the charitable contribution income tax deduction.
- Counting – The value for the purposes of donor recognition and fundraising reporting.
- Economic – The value of the charitable work that will be accomplished by the contribution when it becomes fully available to the organization.
In this post we’re focusing on the value reported on the formal financial statements of your organization, commonly referred to as the “FASB valuation.” Most of us wrestle with FASB requirements once a year when the business office calls during the annual financial audit. Nevertheless, it is helpful to understand the FASB valuation and the variables that affect it.
The bottom line is that this calculation is required because of the very nature of split-interest gifts – an irrevocable contribution combined with an obligation to make payments to one or more beneficiaries for a period of time. The process is straightforward:
- Establish the current value of the gift assets.
- Estimate the total future payment obligation.
- Discount that future obligation back to present value.
The Financial Accounting Standards Board (FASB) sets financial accounting standards. The FASB rules are accounting guidelines. Although they are not statutory rules or regulations, FASB guidelines must be followed to receive a clean audit under Generally Accepted Accounting Principles (GAAP). FASB guidelines require the organization to value annually its irrevocable planned gifts and report them in the annual financial statements. The FASB requirements are designed to create uniformity in reporting and to allow meaningful comparison of financial statements among different charities.
FASB guidelines dictate how split interest gifts (gift annuities, remainder trusts, pooled funds, and retained life estates) are to be valued and reported. FASB guidelines require reporting the current value of the contribution minus the anticipated financial liability for future payments to the income beneficiaries. This “FASB liability” is the calculated amount needed to finance the future payment obligations of a split interest gift. The calculation takes into account the remaining term of the gift, the payout rate or amount, and the interest rate that is used to discount the value of future payments.
The organization selects the discount rate used to calculate the FASB liability. Logic dictates that the discount rate used for each gift should be consistent from year to year. By doing this, the liability for each gift will decline from year to year based on the fact that its beneficiaries get older or its fixed term advances toward completion. Many organizations select a single discount rate that is applied to all planned gifts, and some use the IRS Discount Rates (AFRs) that were used to calculate the charitable deductions for each specific gift.
Although you might expect that the American Institute of Certified Public Accountants (AICPA) would dictate an “AICPA rate” for determining FASB liabilities, there is no such prescribed rate. And unlike the monthly AFR provided by the IRS, neither AICPA nor FASB provides guidance for discount rates for use with FASB liability calculations. No matter how the discount rate is selected, the organization’s auditors will need to be satisfied that the discount rate is reasonable given the economic realities of the organization.
The selection of the FASB discount rate is consequential because the FASB liability amount is sensitive to the discount rate.
Some organizations use the AFR for each specific gift, but others choose the rate of inflation, usually as measured by the Consumer Price Index (CPI). Although the CPI makes intuitive sense, it is notoriously variable. In May 2022, the CPI was 8.6%, but, just a year earlier, it was half that, much closer to the long-term average CPI. Using an 8.6% discount for a contribution in May 2022 could substantially understate the value of the liability.
An alternative to using the CPI is to use an opportunity cost, which represents the potential benefit that the organization foregoes by waiting for the contribution to become available. Opportunity cost is often based upon the expected annual net total return of the endowment portfolio over the long term, perhaps minus the endowment payout percentage. This should be a percentage that rarely requires adjustment.
The purpose of the annual FASB valuation is to report, in a consistent manner, the current net value of the contribution to the organization, taking into consideration the current value of the asset owned by the organization and the projected costs of the obligation to make payments to the beneficiary for the duration of the arrangement. In the simplest terms, the FASB valuation provides an indication of whether a planned gift’s remaining assets will be sufficient to meet its future payment obligations. Although the variables used in the calculation are a matter to be negotiated between management and the auditors, it behooves gift planners to understand how and why the FASB liability is calculated.