August 09, 2011

One of many ways donors provide financial support to charitable organizations is through the use of Split Interest Agreements [ASC 958-30]. Split Interest Agreements are agreements in which donors enter into trusts or other arrangements under which a not-for-profit receives benefits that are shared with other beneficiaries that generally are not not-for-profits [ASC 958-30-05-4]. The most commonly used Split Interest Agreements are i) charitable lead annuity and unit trusts (1), ii) charitable remainder annuity and unit trusts and iii) charitable gift annuities. In instances where a charitable annuity or remainder trust is utilized, assets such as cash or shares of stock are contributed by the donor either to the control of the not-for-profit through its role as trustee of the trust holding the assets or to a third-party trustee (typically a bank, trust company, foundation or private individual).

Recognition

Charitable Lead Trusts (CLT)

Under a CLT, the not-for-profit receives periodic payments (the “lead” interest) during the term of the agreement. At the termination of the agreement, the remaining assets revert to the donor or the donor’s beneficiary (the “remainder” interest).

Charitable Remainder Trusts (CRT)

Under a CRT, the not-for-profit (or the trust) makes periodic payments to the donor (the “lead” interest) or the donor’s beneficiary during the term of the agreement. At the termination of the agreement, the remaining assets revert to the not-for-profit (the “remainder” interest).

Charitable Gift Annuities (CGA)

Under a CGA, the donor and not-for-profit enter into an agreement whereby the donor contributes assets (typically cash or shares of stock) to the not-for-profit in exchange for a promise by the not-for-profit to pay a fixed amount for a specified period of time to the donor or individuals or entities designated by the donor. CGAs are similar to CRTs except that no trust exists. The assets received are held as general assets of the not-for-profit and the annuity liability is a general obligation of the not-for-profit.


Recording

Not-for-profits that are a party to Split Interest Agreements and hold the assets of the Split Interest Agreement, absence any donor imposed conditions should recognize the Split Interest Agreement as contribution revenue along with the related assets and liabilities when named as a trustee or fiscal agent of an irrevocable Split Interest Agreement (2). Not-for-profits that are party to Split Interest Agreements which the not-for-profit has an unconditional right to receive all or a portion of the specified cash flows from the assets in which a third-party maintains control of the donor’s contributed assets, should recognize its beneficial interest in those assets as an asset and contribution revenue when the not-for-profit is notified of the Split Interest Agreements existence.

 
Unfortunately, not-for-profits may not always be recording Split Interest Agreements, may not be recording them correctly or may not realize that they are a party to an Split Interest Agreement at all. As a result, not-for-profits may be understating assets, liabilities, revenue and net assets. The following are examples of what might result when using appropriate auditing procedures, inquiries, analytics and questionnaires during an audit of Organization’s contributions.

Example 1  

During its initial year-end audit of Organization X, the audit firm, as part of its testing of contributions, selected a $25,000 unrestricted contribution made to it by Donor Y. Upon reviewing the supporting documentation maintained by Organization X, it revealed that the Organization has been receiving $25,000 for several years and will for a number of years to come under a charitable lead trust created by Donor Y naming Organization X as the “lead” interest recipient. For the past several years, Organization X has been recording, each year, the $25,000 contribution as unrestricted revenue in the year received. What Organization X should have recorded in the initial year was an unrestricted contribution of $25,000 (the net asset classification dependent upon Donor Y’s stipulation in the CLT agreement) and the present value of the balance to be received as a beneficial interest in the Split Interest Agreement (an asset) along with temporarily restricted contribution revenue due to the inherent time restriction on the receipt of the future funds in the same amount (3). As a result, Organization X has understated its assets, contributions and net assets due to not properly recording the CLT.

Example 2  

Same facts as in example 1, except as the audit team was reviewing Donor Y’s file, they noticed that Donor Y also created a CRT with a third-party naming Organization X as the “remainder” interest in the agreement and the remainder interest is to be placed in Organization X’s permanent endowment. Organization Y has not recorded the CRT as they claim that the amount that will ultimately be received cannot be determined. What Organization X should have recorded in the initial year was a beneficial interest in the Split Interest Agreement (an asset) and a permanently restricted contribution for the fair value of the amount that Organization X expected to receive upon the creation of the CRT (the fair value could be estimated based on the fair value of the assets contributed by the donor less the fair value of the payments to be made to other beneficiaries during the term of the CRT) (4). As a result, Organization X has understated its assets, contributions and net assets due to not properly and not knowing how to record the CRT.

Example 3 

During its initial year-end audit of Organization Z, the audit team noticed an expense item labeled “annuitant expense”. Upon inquiry of the nature of this item with Organization Z’s business manager, the audit team was informed that several years ago the Organization received assets from Donor A and in return, Donor A was to be paid a fixed amount for a specified period of time, and the donated assets could be used without any restrictions (a CGA). Upon further discussions, the business manager said that per instructions from the CFO, the total amount received by Organization Z should immediately be recognized as unrestricted revenue and the annual payments should be recorded as an expense. Additionally, neither the agreement, nor state law required the assets to be invested until Donor A’s (income beneficiary) death. What Organization Z should have recorded in the initial year of the CGA was a liability for the fair value (present value of the future payments if present value techniques are used) of the future payments to be made to Donor A and unrestricted revenue for the difference between the assets transferred and the liability (5). As a result, Organization Z has understated its liabilities and overstated its contributions and net assets due to not properly recording the CGA.

Conclusion  

Not-for-profits receive contributions and support in many ways and the types of split-interest agreements discussed above are just a few. It is imperative that not-for-profits review supporting documentation pertaining to all types of charitable giving, especially Split Interest Agreements. Each one carries with it specific characteristics and rules, and an added nuance to an Split Interest Agreement or not adhering to a rule of one, may cause the financial statements of an Organization to be misstated. Carefully review accounting records, development department documents and files, ask lots of pointed questions during inquiries of Organization personnel and don’t accept an “I don’t know” or “that’s how we’ve always done it” as a response.


(1) During the term of the agreement, an annuity trust makes periodic payments that are a fixed dollar amount while a unit trust makes periodic payments of a specified percentage of the fair value of the assets in the trust at the beginning of each period.

(2) If assets are received by an not-for-profit and the Split Interest Agreement is revocable, the assets are to be recorded as assets and refundable advances. Contribution revenue for the assets received should be recognized when the agreement becomes irrevocable or when the assets are distributed to the not-for-profit, whichever comes first.

(3) See ASC 958-30-55-30 for sample journal entries for each subsequent year to record the receipt of the $25,000 and the revaluation of the beneficial interest in the Split Interest Agreement as well as upon termination of the Split Interest Agreement.

(4) See ASC 958-30-55-30 for sample journal entries for each subsequent year’s revaluation of the beneficial interest in the Split Interest Agreement as well as upon termination of the Split Interest Agreement.

(5) See ASC 958-30-55-30 for sample journal entries for each subsequent year’s payments to the annuitant, revaluation of the liability pursuant to the Split Interest Agreement as well as upon termination of the Split Interest Agreement.