Examples of Split-Interest Agreements

Transcription

1 Examples of Split-Interest Agreements Many kinds of split-interest agreements have been developed. The examples in this section demonstrate how the recognition and measurement principles apply to some common kinds of agreements. Often with irrevocable trusts or annuities, agreements to carry the memory of a loved one may be made between the donor and the organization as determined by the size and/or duration of a gift. Charitable Gift Annuity 6.52 A charitable gift annuity is an arrangement between a donor and an NFP in which the donor contributes assets to the NFP in exchange for a promise by the NFP to pay a fixed amount for a specified period of time to the donor or to individuals or entities designated by the donor. The agreements are similar to charitable remainder annuity trusts except that no trust exists, the assets received are held as general assets of the NFP, and the annuity liability is a general obligation of the NFP For example, NFP A and a donor enter into an arrangement whereby assets are transferred from the donor to NFP A. NFP A agrees to pay a stated dollar amount annually to the donor's spouse until the spouse dies NFP A should recognize the agreement in the period in which the contract is executed. The assets received should be recognized at fair value when received, and an annuity payment liability should be recognized at fair value as discussed in paragraphs In this example, unrestricted 5 contribution revenue should be recognized as the difference between these two amounts. 5 Paragraph 6.08 discusses the classification of the contribution portion of a charitable gift annuity agreement. Paragraphs discuss classification and disclosure of reserve requirements or other limitations imposed by state law on NFPs that hold charitable gift annuities In subsequent periods, payments to the donor's spouse reduce the annuity liability. Adjustments to the annuity liability to reflect amortization of the discount and changes in the life expectancy of the donor's spouse should be recognized in a statement of activities as changes in the value of split-interest agreements in unrestricted net assets. Upon the death of the donor's spouse, the annuity liability should be closed and a change in the value of split-interest agreements should be recognized in the statement of activities. Charitable Remainder Trust 6.47 A charitable remainder trust is an arrangement in which a donor establishes and funds a trust with specified distributions to be made to a designated beneficiary or beneficiaries over the trust's term. Upon termination of the trust, an NFP receives the assets remaining in the trust. The NFP may ultimately have unrestricted use of those assets, or the donor may place permanent or temporary restrictions on their use. The distributions to the beneficiaries may be for a specified

2 dollar amount, an arrangement called a charitable remainder annuity trust, or for a specified percentage of the trust's fair market value as determined annually, a charitable remainder unitrust. Some charitable remainder unitrusts limit the annual payout to the lesser of the stated percentage or the actual income earned. Obligations to the beneficiaries are limited to the trust's assets For example, a donor establishes a charitable remainder unitrust, with NFP B serving as trustee. Under the trust's terms, the donor's spouse is to receive an annual distribution equal in value to a specified percentage of the fair market value of the trust's assets each year until the spouse dies. The income earned on the trust's assets must remain in the trust until the spouse dies. At that time, the remaining assets of the trust are to be distributed to NFP B for use as a permanent endowment NFP B should recognize the contribution in the period in which the trust is established. The assets held in trust by NFP B and the liability to the donor s spouse should be recorded at fair value when received, as discussed in paragraphs If the liability is measured using present value techniques, the liability to the donor's spouse should be recorded at the present value of the future payments to be distributed over the spouse's expected life. The amount of the contribution is the difference between these amounts and should be classified as permanently restricted support In subsequent periods, income earned on trust assets, recognized gains and losses, and distributions paid to the spouse should be reflected in the NFP B's statement of financial position. Adjustments to the liability to reflect amortization of the discount, revaluations of the present value of the estimated future payments to the spouse, and changes in actuarial assumptions should be recognized in a statement of activities as a change in the value of splitinterest agreements in the permanently restricted net asset class. Upon the death of the spouse, the liability should be closed and any balance should be recognized as a change in the value of split-interest agreements in the statement of activities in the permanently restricted net asset class. (In this example, the period for which distributions were made to the beneficiary was dependent solely on the donor s death and the payment amounts varied based on the fair value of the unitrust assets. If instead the variable-amount distributions were required to be paid for a specified number of years or for the greater of the donor s life or a specified number of years, the liability to the beneficiary would have contained an embedded derivative, as discussed in paragraph Paragraphs discuss measuring an obligation that contains an embedded derivative.) 6.51 If NFP B is not the trustee and does not exercise control over the assets contributed to the trust, the agreement should be recognized as a beneficial interest in a trust. NFP B should recognize, as permanently restricted contribution revenue and as a beneficial interest, the fair value of the beneficial interest, as discussed in paragraphs Adjustments to the beneficial interest to reflect changes in the fair value should be measured using the same valuation technique as was used to measure the asset initially and recognized as changes in the value of split-interest agreements. For example, if present value techniques were used to estimate fair value, the adjustment would reflect the revision of all elements discussed in FASB ASC , including the passage of time, revaluation of the present value of the future payments

3 to the spouse, changes in actuarial assumptions during the term of the trust, and discount rates based on current market conditions. Upon the death of the spouse, the beneficial interest is closed, the assets received from the trust are recognized at fair value, and any difference is reported as a change in the value of split-interest agreements in permanently restricted net assets. Perpetual Trust Held by a Third Party 6.43 According to the FASB ASC glossary, a perpetual trust held by a third party is an arrangement in which a donor establishes and funds a perpetual trust administered by an individual or entity other than the NFP that is the beneficiary. 4 Under the terms of the trust, the NFP has the irrevocable right to receive the income earned on the trust assets in perpetuity, but never receives the assets held in trust. Distributions received by the NFP may be restricted by the donor. 4 Chapter 5, "Contributions Received and Agency Transactions," provides guidance for transactions in which a perpetual trust held by a third party (trustee or other recipient organization) is established by an NFP for its own benefit or for the benefit of its affiliate For example, a donor establishes a trust with the donor's bank serving as trustee. Funds contributed to the trust are to be invested in perpetuity. Under the terms of the trust, NFP C is to be the sole beneficiary and is to receive annually the income on the trust's assets as earned in perpetuity. NFP C can use the distributions from the trust in any way that is consistent with its mission The arrangement should be recognized by NFP C as contribution revenue and as an asset, measured at fair value, when the NFP C is notified of the trust's existence, as discussed in paragraph FASB ASC states that the fair value of a perpetual trust held by a third party generally can be measured using the fair value of the assets contributed to the trust, unless 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 contribution should be classified as permanently restricted support because the trust is similar to donor restricted permanent endowment that the NFP C does not control, rather than a multiyear promise to give. Pursuant to FASB ASC , annual distributions from the trust are reported as investment income. In this example, the investment income increases unrestricted net assets Periodically in conjunction with preparing its financial statements, NFP C should remeasure its beneficial interest at fair value, using the same valuation technique that was used to measure the asset initially, as described in paragraph In this example, the adjustment should be recognized as permanently restricted gains or losses. Charitable Lead Trust 6.38 A charitable lead trust is an arrangement in which a donor establishes and funds a trust with specific distributions to be made to a designated NFP over a specified period. The NFP's use of the assets distributed may be restricted by the donor. The distributions may be for a fixed dollar

4 amount, an arrangement called a charitable lead annuity trust, or for a fixed percentage of the trust's fair market value as determined annually, a charitable lead unitrust. Upon termination of the trust, the remainder of the trust assets is paid to the donor or to the beneficiaries designated by the donor For example, NFP D receives cash from a donor under an irrevocable charitable lead annuity trust agreement designating NFP D as trustee and lead beneficiary. Under the terms of the trust, NFP D will invest the assets and receive a specified dollar amount each year for its unrestricted use until the death of the donor. At that time, the remaining assets in the trust revert to the donor's estate Contribution revenue, assets held in trust, and a liability for amounts held for others should be recognized by NFP D in the period in which the trust is established. Revenue should be reported as temporarily restricted support and measured at fair value. The present value of the specified dollar amount to be received annually over the expected life of the donor is one possible technique to measure the fair value of the contribution. The assets held in trust by NFP D should be recorded at fair value at the date of initial recognition. The difference between the fair value of the assets received and the contribution revenue represents the present value of the liability to pay the donor's estate upon the termination of the trust In subsequent periods, both the income earned on the trust assets and recognized gains and losses should be reflected in the trust asset and liability accounts. Adjustments of the liability to reflect amortization of the discount and revaluations of the future cash flows based on revisions in the donor's life expectancy should be recognized as changes in the value of split-interest agreements and classified as changes in temporarily restricted net assets in a statement of activities. Amounts should be reclassified from temporarily restricted to unrestricted net assets as the annual distributions to NFP D are made and recognized during the term of the trust. Upon the death of the donor, the assets are distributed to the donor's estate, the asset and liability accounts are closed, and any difference between the balances in those accounts should be recognized as a change in the value of split-interest agreements in the temporarily restricted net asset class. (In this example, the timing of the distribution of the remainder interest to the beneficiary was dependent on the donor s death. If instead the distribution were required to be paid at the end of a specified period, the liability to the beneficiary would have contained an embedded derivative as described in paragraph Paragraphs discuss measuring an obligation that contains an embedded derivative.) 6.42 If NFP D is not the trustee and does not exercise control over the trust's assets, it should recognize its beneficial interest in those assets as temporarily restricted contribution revenue and as a beneficial interest, measured at fair value as discussed in paragraphs Distributions from the trust should be reflected as a reduction in the beneficial interest and as reclassifications from temporarily restricted net assets to unrestricted net assets. Changes in the fair value of the beneficial interest should be recognized as adjustments to the beneficial interest in the statement of financial position and as changes in the value of split-interest agreements in the statement of activities in the temporarily restricted net asset class. If present value techniques are used to estimate fair value, those changes would reflect the revision of all elements discussed in FASB ASC , including the passage of time, revaluations of expected future

5 cash flows based on revisions in the donor's life expectancy, and discount rate assumptions to reflect current market conditions. Any balance in the beneficial interest account remaining upon termination of the trust should be recognized as a change in the value of split-interest agreements in the statement of activities in the temporarily restricted net asset class. Pooled (Life) Income Fund 6.56 Some NFPs form, invest, and manage pooled (or life) income funds. 6 These funds are divided into units, and contributions of many donors' life-income gifts are pooled and invested as a group. The FASB ASC glossary defines a pooled income fund as a trust in which donors are assigned a specific number of units based on the proportion of the fair value of their contributions to the total fair value of the pooled income fund on the date of the donor's entry to the pooled fund. Until a donor's death, the donor (or the donor's designated beneficiary or beneficiaries) is paid the actual income (as defined under the arrangement) earned on the donor's assigned units. Upon the donor's death, the value of these assigned units reverts to the NFP. 6 Net income unitrusts are similar to pooled life-income funds, because the corpus is maintained. Accordingly, financial reporting for net income unitrusts is similar to reporting for pooled life-income funds For example, a donor contributes assets to NFP E's pooled (life) income fund and is assigned a specific number of units in the pool. The donor is to receive a life interest in any income earned on those units. Upon the donor's death, the value of the units is available to NFP E for its unrestricted use NFP E should recognize its remainder interest in the assets received as temporarily restricted contribution revenue in the period in which the assets are received from the donor. The contribution should be measured at fair value. Present value techniques are one valuation technique for measuring the fair value of the contribution. If present value techniques are used, the contribution may be measured at the fair value of the assets to be received, discounted for the estimated time period until the donor's death. The contributed assets should be recognized at fair value when received. The difference between the fair value of the assets when received and the revenue recognized should be recorded as deferred revenue, representing the amount of the discount for future interest Periodic income on the fund and payments to the donor should be reflected as increases and decreases in a liability to the donor. Amortization of the discount should be recognized as a reduction in the deferred revenue account and as a change in the value of split-interest agreements and reported as a change in temporarily restricted net assets. Upon the donor's death, any remaining balance in the deferred revenue account should be closed and a change in the value of split-interest agreements should be recognized. A reclassification to unrestricted net assets is also necessary to record the satisfaction of the time restriction on temporarily restricted net assets.