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By Lawrence M. Metzger Ph.D., CPA, CMA, Loyola University Chicago

Perhaps no single sentence in SFAS Statement No. 116, Accounting for Contributions Made and Contributions Received, is more controversial and ambiguous than the one beginning paragraph 20:

    The present value of estimated future cash flows using a discount rate commensurate with the risks involved is an appropriate measure of a fair value of unconditional promises to give cash.

The recognition of future pledges to give as revenue in the current period on a discounted basis and in the temporarily restricted asset class was a major point of contention in the statement. For instance, the chairman of the FASB, Dennis Beresford, dissented on the issuance of the statement because it required recipients of unconditional promises to recognize assets and revenues in the period the promise is received. In particular, he questioned whether the recognition of revenues for restricted gifts, especially for promises collectible in the distant future, results in more meaningful financial reporting. Organizations that rely heavily on annual pledge drives will report large increases in net assets if promises are recorded. He was concerned the amounts will be regarded as surplus resources or otherwise misinterpreted by financial statement users.

Whether controversial and ambiguous or not, the time has come for implementation. SFAS No. 116 and the related SFAS No. 117, Financial Statements of Not-for-Profit Organizations, is required reporting for not-for-profits for financial statements issued for fiscal years beginning after December 15, 1994, for those organizations with more than $5 million in total assets and $1 million in annual expenses. For organizations with lessor amounts, the effective date is for fiscal years beginning after December 15, 1995.

Accounting for Discounted Pledges

A pledge of money to be received in future periods is, by definition of the FASB, a time-restricted pledge. The mere fact a pledge is restricted does not keep it from being reported as revenue in the period pledged. All unconditional, restricted pledges are recorded in the year the pledge is made. The portion received in the year of the gift in cash is recorded as unrestricted support and increases unrestricted net assets. The remaining portion of the pledge is reported as temporarily restricted support and increases temporarily restricted net assets.

Example. Assume that on the first day of a new year, a not-for-profit organization receives an unconditional pledge of $25,000 per year for five years. Assume all payments are to be made on the first day of each calendar year, beginning January 1st of the year of the pledge.

How should this pledge commitment be recognized? A starting point in a situation like this is to ask if there is anything in general accounting and reporting analogous to this situation. The pledge is, in substance, a long-term note receivable. While the legal aspects may be different--the pledge may not be legally enforceable--there are similarities between the pledge and a long-term note receivable, especially a note receivable where an implicit interest rate must be determined. Accounting Principles Board (APB) Opinion No. 21, Interest on Receivables and Payables, requires that a long-term note receivable be discounted using the market rate if the rate on the note is not equivalent to the market rate. An application of this approach may provide some clarification.

How will the interest rate be developed? Paragraph 20 of SFAS No. 116 says to use a rate that is commensurate with the risks involved. This provides little specific guidance. Paragraph 13 of APB No. 21 says:

    The variety of transactions encountered precludes any specific interest rate from being applicable in all circumstances. However, some general rules may be stated. The choice of rate may be affected by the credit standing of the issuer, restrictive covenants, collateral, payment, and other terms pertaining to the debt...The objective is to approximate the rate that would have resulted if an independent borrower and an independent lender had negotiated a similar transaction under comparable terms and conditions...

For this example, assume a specific rate of 10%. How do the mechanics flow? A pledge of money over the next five years, given in equal amounts at the beginning of each year is similar in form to an annuity due. The present value factor for an annuity due for five periods (years) beginning today (January 1st, year one) with a constant interest rate of 10% is 4.1699. So, the present value of the these future cash flows is calculated as $25,000 x 4.1699= $104,248.

According to paragraph 21 of SFAS No. 116, the pledges expected to be received within the year do not have to be shown at the discounted amount. So, the entire first year pledge of $25,000 can be shown as unrestricted revenue. Temporarily restricted revenue would also be recorded when the pledge is made. This amount will be the difference between the discounted receivable and the unrestricted revenue, that is $104,248­ $25,000=$79,248. This temporarily (time) restricted revenue will be reported on the not-for-profit's statement of activities, as required under SFAS 117. The pledge receivable will be broken down between unrestricted net assets and temporarily restricted net assets.

Paragraph 20 of SFAS 116 also states that when discounting future cash flows, "subsequent accruals of the interest element shall be accounted for as contribution income by donees." To determine the numbers for this process, an amortization schedule should be developed for the receivable. This amortization schedule is shown in Exhibit 1.

The entries to record the initial recording of the pledge as well as the cash received on January 1 of year one are the first two entries in Exhibit 2.

At the end of each year, an accrual of the interest component of the present value must be recognized. The example uses the preferred method of APB No. 21, the effective interest method. This represents a constant (10%) interest rate applied against a declining receivable balance. Entry number 3 in Exhibit 2 would be made to record this amortization.

The column marked "released restrictions" in Exhibit 1 represents the amount of the restricted revenue that has been "released" from restrictions and is moved into unrestricted revenue. This column is the difference between the cash received and the interest amortization. Two entries are made for this release. The first is a transfer from restricted to unrestricted pledges receivable as shown by entry number 4. The second is either a general ledger or working paper entry transferring the amount from restricted to unrestricted net assets as shown in entry number 5.

Entry number 4, along with the entry for interest amortization, will yield a $25,000 ($17,075 + $7,925) receivable balance in unrestricted net assets at December 31st, year one. This represents the $25,000 that will be collected on January 1st of the following year.

The $50,000 in unrestricted net assets at the end of year one will show as $32,925 in contributions and $17,075 of transfers from restricted in the statement of activities. The $62,173 restricted pledge receivable is the $79,248 original restricted receivable minus the released restriction of $17,075. Over the life of the pledge, the entire amount of the restricted pledge will be "released" into the unrestricted net asset category.

Comparable entries to entries 2 through 5 will be made for subsequent years based on the amortization schedule in Exhibit 1 until the pledge is completely collected. On the first day of each of the remaining years, the firm will debit cash and credit pledges receivable-unrestricted for $25,000. At December 31 of each year, entries will be made to record the interest amortization and the release from restriction. The final entry will be made on January 1st of year five when the final cash installment is received.

Interest Rate Choice

The choice of an interest rate will not affect the total amount of revenue recognized over the life of the pledge. It will, however, affect the timing of the revenue. A higher discount rate will show less revenue in the first year of the pledge, while a lower rate will increase first year contributions. For example, at a 12% interest rate, the discount factor is 4.0373. So $25,000 x 4.0373 = $100,933. On January 1st year one, $25,000 of unrestricted revenue plus $75,933 of restricted revenue would be recognized. At December 31st, the amortization of interest at 12% would be $9,112, i.e., $75,933 x 12%. Total revenue for year one would be $110,045, ($25,000 + $75,933 + $9,112). This is slightly lower than the $112,173 revenue shown in year one at the 10% rate. Of course, the choice of the discount rate will not affect cash flow.

Reporting Pre-SFAS No. 116 Pledges Under New Requirements

Paragraph 29 of SFAS No. 116 states, "unless the statement is applied retroactively, the effect of initially applying this statement shall be reported as the effect of a change in accounting principle in a manner similar to the cumulative effect of a change in accounting principle (APB Opinion No. 20). The amount of the cumulative effect shall be based on a retroactive computation, except that the expirations of restrictions may be applied prospectively. A not-for-profit organization shall report the cumulative effect of a change in accounting on each class of net assets in the statement of activities."

Example. Assume the same information as before except the pledge was received two years before the required reporting under SFAS No. 116. Also assume the first two years were reported as contribution revenue of $25,000 per year with no recognition of a pledge receivable on the financial statements. At the beginning of year three, the firm adopts SFAS No. 116. A determination of a cumulative effect of the change in accounting principle in substance tries to catch up the reporting as if the new principle had always been in effect. For the first two years, a total of $50,000 had been reported as contribution revenue. As indicated by the cumulative totals at the end of year 2 in Exhibit 2, had SFAS No. 116 been used from the start, and assuming the same 10% rate, a total of $118,390 would have been shown as revenue ($79,248 + $25,000 +$7,925 + $6,217). Total pledges receivable at 1/1/x3 would have been $68,390, that is $25,000 + $43,390. During the first two years under SFAS No. 116, unrestricted revenue would have been $39,142 ($25,000 + $7,925 + $6,217) and total released restrictions transferred to unrestricted net assets would have been $35,858 ($17,075 + $18,783), increasing unrestricted net assets by $75,000. Deducting the $50,000 contribution revenue already recognized leaves a cumulative effect of a $25,000 increase in unrestricted net assets needed to catch up or adjust for the new statement.

Temporarily restricted net assets would have increased by $43,390 during the first two years of the pledge had the statement been in effect. The total increase to net assets then is $25,000 + $43,390 = $68,390, the same as the opening receivable balance at 1/1/x3. The entry to reflect the cumulative effect of the change in accounting principle at 1/1/x3 would be as follows:

Pledges receivable­

unrestricted $25,000

Pledges receivable­temporarily

restricted 43,390

Cumulative effect­unrestricted

net assets (25,000)

Cumulative effect­restricted

net assets (43,390)

According to SFAS No. 116, the cumulative effect shall be shown in each class of net assets in the statement of activities between the captions "extraordinary items," if any, and "change in unrestricted net assets," and "change in temporarily restricted net assets."

SFAS No. 116 may also be applied "retroactively by restating opening net assets for the earliest year presented or for the year this statement is first applied if no prior years are presented."

In this example, the same entry would be recorded except that the credits would be made directly to net asset accounts rather than through cumulative effects.

At the end of year three, the change in net assets from this entry would be shown on the statement of activities as an adjustment (increase) to beginning net assets.

Once this cumulative effect is recognized, the current year's financial statements reflect the new accounting rules. The entries for the remainder of the pledge period (years 3 to 5) would be the same as discussed in Exhibit 2. *


Douglas R. Carmichael, PhD, CPA

Baruch College


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