Nonprofit & Government Times Q1 2020

Nonprofit & Government Times

FIRST QUARTER, 2020

IN THIS ISSUE

Welcome. “We must become more comfortable with probability and uncertainty.” This quote from political mastermind Nate Silver is just as applicable to the nonprofit sector as it is to the political sector—and even more relevant in light of the recent coronavirus situation. As our nonprofit clients continue to adjust to and grapple with a host of uncertainties and ambiguities during these challenging times, receiving the right advice from Marks Paneth is one thing they can always count on. We know that having timely information at your fingertips can help you plan effectively. In our latest issue of Nonprofit & Government Times , we are pleased to provide you with information on the most recent developments affecting you and your organization. From the proper reporting and valuation of in-kind contributions, to alternative funding sources, to footnote disclosure overload and new GASB statements, this issue is replete with guidance to help you fulfill your mission and goals. We have also included some COVID-19 Nonprofit Resources on page 2 of the newsletter. And as we review the provisions of the recently passed CARES Act, we will continue to keep you apprised of how this legislation will affect you. You may also visit our Pandemic Resource Center for additional updates and guidance on COVID-19. As always, we’re eager to help you and share our knowledge about the complex issues facing us all today. Please contact me or any other member of our Group if you have any questions about the articles in this newsletter. We look forward to continuing to be the trusted advisors you turn to for help in the constantly evolving nonprofit landscape.

2 COVID-19 Nonprofit Resources 3 ADDITIONAL REVENUE SOURCES for Nonprofits Magdalena M. Czerniawski 6 EDUCATING YOUR BOARD About Nonprofit Accounting Matthew Castellano 9 FOOTNOTE DISCLOSURE Overload John D’Amico 13 A Guide to Proper Reporting and Valuation of IN-KIND CONTRIBUTIONS Joseph Kanjamala 18 NOT-FOR-PROFIT RAFFLES: Don’t Gamble with Federal and State Requirements Magdalena M. Czerniawski Robert Lyons 22 GASB STATEMENTS Effective for the Year Ended December 31, 2019 Philip Marciano 24 LEVERAGE OUR EXPERTISE

HOPE GOLDSTEIN CO-PARTNER-IN-CHARGE, NONPROFIT, GOVERNMENT & HEALTHCARE GROUP 212.503.6351

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COVID-19 Nonprofit Resources

BUSINESS CONTINUITY/DISASTER RECOVERY PREPAREDNESS CHECKLIST T he evolving threat of the coronavirus (COVID-19) is placing business continuity planning efforts top of mind. Organizations need to balance how they safeguard and keep their employees safe while mitigating the risk of adverse financial and operational effects. Ongoing assessment of threats and risks is key to maintaining the most up-to-date plans, and testing and maintenance are essential to validate strategies and assumptions and identify any gaps in business continuity planning. Marks Paneth’s Business Continuity/Disaster Recovery Preparedness Checklist , developed by Melissa Ouari , Senior Manager in the firm’s Technology Services Group, provides concrete actions organizations can take to minimize disruption and respond to crises like the coronavirus outbreak more effectively.

NYC EMPLOYEE RETENTION GRANT PROGRAM

New York City is offering small businesses and nonprofits with fewer than five employees a grant to cover 40% of payroll costs for two months to help retain employees. For up-to-date information from the NYC Department of Health on this quickly evolving situation, please visit www.nyc.gov/coronavirus . For best business practices and updates on financial assistance, please visit https://www1.nyc.gov/site/sbs/businesses/ covid19-business-financial-assistance.page . You may also contact your relationship partner at Marks Paneth with questions or to discuss further. The Small Business Association (SBA) has announced that it will be offering disaster assistance loans for small businesses, including nonprofits, impacted by the coronavirus. These business loans may be used to pay fixed debts, payroll, accounts payable and other bills that can’t be paid because of the disaster’s impact. The interest rate for nonprofits is 2.75%. For more information, please visit https://www.sba.gov/ about-sba/sba-newsroom/press-releases-media- advisories/sba-provide-disaster-assistance-loans- small-businesses-impacted-coronavirus-covid-19 or contact your Marks Paneth relationship partner. SBA DISASTER ASSISTANCE LOANS

DOWNLOAD CHECKLIST

For updates and guidance on the COVID-19 outbreak, please visit Marks Paneth’s Pandemic Resource Center .

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Additional Revenue Sources for Nonprofits MAGDALENA M. CZERNIAWSKI, CPA, MBA TAX PARTNER, NONPROFIT, GOVERNMENT & HEALTHCARE GROUP

B y definition, nonprofit organizations focus on supporting their mission instead of benefiting shareholders. Many nonprofits are supported by providing services to various individuals for which they receive reimbursement by the government. However, reduced government funding has led nonprofit organizations to look for alter- native revenue sources. In this challenging environment, it is imperative that nonprofit executives think outside the box about how to raise funds from various sources. This does not come naturally to most nonprofit executives, but it can be a big differentiator.

ENGAGED BOARD OF DIRECTORS

Let’s start with the core of the nonprofit—its Board of Directors. An engaged Board is important for a non- profit organization. A high level of engagement from the Board will not only help the nonprofit remain focused on its mission, but also facilitate its growth. Attracting good Board members can be a challenge, but nonprofits, like for-profit businesses, need to focus on networking and finding followers. Engaged Board members can provide their time and resources and find other potential donors who can do the same. How can a nonprofit attract such Board members? A clear mission statement is key. Every employee of a nonprofit should be able to articulate its mission, which should be clear and concise and resonate with others. If the nonprofit’s mission is well defined, then potential

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It’s important not to lose sight of potential tax consequences of these types of income streams.

Board members will be able to fully support it with a clear understanding. More importantly, they’ll also be able to communicate that mission to others, including potential donors. This will enable them to grow their donor base with people who believe in their mission and trust the organization.

Many corporate entities happily engage in various volunteering activities or raise funds for various charities. Nonprofit organizations should consult with their tax advisors to ensure that any contracts for this type of fundraising are structured to avoid generating taxable income.

ONLINE PRESENCE

DONOR ADVISED FUNDS

In today’s world, nonprofits are shortsighted if they don’t sufficiently invest in an online presence. What we are hearing from many is that their staff is too busy and they don’t have funds for a dedicated person to handle their digital activities. However, the cost is relatively small compared with the potential impact. A post on social media can show the great things the organization does in real time and also raise funds more quickly by including a donation link in the post. Although these online donations might not be large, they can add up quickly. A strong online presence can also raise aware- ness of the nonprofit’s mission among potential donors, providing an easy way to broadcast the message and engage more individuals and companies. CAUSE-RELATED MARKETING Another way to raise additional funds is through cause-related marketing such as AmazonSmile, which donates 0.5% of the purchase price of eligible prod- ucts to charitable organizations. Nonprofit organiza- tions can easily register on Amazon.com to receive AmazonSmile donations. They can also partner with local stores or for-profit businesses that donate part of their proceeds or solicit on the organization’s behalf.

Another source of additional funds that is growing in popularity is the Donor Advised Fund (DAF). A DAF is a giving vehicle established at a public charity that allows donors to make a charitable contribution, receive an immediate tax deduction and recommend grants from the fund over time. Donors can contribute to the fund as frequently as they like and recommend grants to their favorite charities whenever they like. This type of fundraising has spiked with the Tax Act Reform of 2017, which increased the standard deduc- tion and provided an incentive for donors to make deductions once every two years in order to save tax dollars. Over the past few years, some donors have chosen to create DAFs instead of private foundations. Nonprofit organizations should also consider them in their solicitation plans. One of the simplest ways to do this is to include language on the organization’s website stating that the organization accepts dona- tions from DAFs. In addition, unlike private foundations, pledges can be satisfied with monies from DAFs. 1 This could be a great option when donors don’t want to spend additional cash but have funds available in their DAFs. Since there

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are no distribution requirements for the DAF, some of these donors may be accumulating quite a large amount of money, which can benefit nonprofits. Once the donor establishes a relationship with the nonprofit, those gifts will likely continue into the future. Another great feature is that the donor can remain anonymous. Therefore, the organization won’t be required to disclose the donation to the government agencies on its Schedule B – Schedule of Contributors that is filed with Form 990. In short, as DAFs are becoming more popular, nonprof- it organizations should consider tapping into that pool of funds. Various fundraising events can also generate discretion- ary funds for an organization. These events do not necessarily have to be costly galas. Marathon charity runs and birthday fundraising events are becoming more prevalent, especially among the younger genera- tion. Funds are raised through volunteers or friends and followers of charities who host events to benefit the organization. They are more effective if the organization has a good online presence, as described above, and can easily be found and supported. FUNDRAISING EVENTS

tax-exempt entity that is outside of its mission. UBTI prevents or limits tax-exempt entities from engaging in businesses that are unrelated to their primary purposes, but sometimes it is worth accepting some tax liability to create additional income streams for the organization. This decision should be reviewed with tax advisors before commencing such activity. OTHER SOURCES There are also more traditional sources of additional income, such as renting the nonprofit’s excess space to others or investing excess cash. Although invest- ments are more common, they depend on the charity’s appetite for risk. Some nonprofits prefer only very safe investments, whereas others are willing to accept more risk to generate a little more income. Every charity should feel comfortable with whatever decision they make, without jeopardizing any potential assets. Again, it’s important not to lose sight of potential tax consequences of these types of income streams. CONCLUSION A healthy combination of the above approaches—or at least a consideration of them—can prove to be financially beneficial for nonprofit organizations in these financially challenging times. Although the organization may not need to raise funds today, it should think about generating donations and attracting Board members and other constituents for tomorrow.

UBTI

Most charities try to avoid Unrelated Business Taxable Income (UBTI), i.e., income regularly generated by a

1. IRS Notice 2017-73

Magdalena M. Czerniawski, CPA, MBA , Tax Partner in the firm’s Nonprofit, Government & Healthcare Group, provides tax services to a wide array of nonprofits, including charitable organizations, social welfare organizations, professional associations and private foundations. She specializes in matters related to ASC 740-10 (FIN 48), the reporting requirements that govern contributions, compensation, unrelated business taxable income, lobbying costs and public support testing. Magdalena can be reached via email at mczerniawski@markspaneth.com or at 212.324.7026.

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Educating Your Board About Nonprofit Accounting MATTHEW CASTELLANO, CPA SENIOR MANAGER, NONPROFIT, GOVERNMENT & HEALTHCARE GROUP

T he Boards of Directors of nonprofit organizations are full of reputable individuals who share their expertise, energy and judgment because they care about the organization’s cause. The Board is not self-serving, but selfless, and organiza- tions rely on them to further their mission. Board members come from a multitude of backgrounds and industries, serving as

excellent resources for many facets of a nonprofit, but one area of specialty where it can be hard to find an expert for a Board is nonprofit accounting. This can put nonprofit management in a difficult position when trying to explain the organization’s numbers and financial position to their Board.

The majority of nonprofits budget at breakeven with the anticipation that expenses will be covered by

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Management must educate their Board members so that they understand that there is a lot of gray area from service to service, and from budget line item to budget line item.

income. To manage liquidity, nonprofits rely on collection of accounts receivable for their general expenditures. When there are timing or collection issues with accounts receivable, organizations must dip into reserves or borrow on lines of credit to cover short-term expenditures. In other words, nonprofits do not operate like most other businesses, which creates an education gap between nonprofit management and their Boards. When presenting your budget to the Board of Directors, you will present your projected revenue. If you are a human services organization, your projec- tion will likely include your current census of resi- dents, multiplied by your rate. But what if you do not have a final rate? How do you explain to your Board that although you are currently being paid a prospec- tive rate, you are not sure when you will know what the final rate and potential recoupment will be? In addition, you need to explain that the rate you are getting for the service is not dollar for dollar; the cost of what you are providing is substantially higher. With prospective rates, rate component cutbacks and recoupments considered common practice in this industry, Board members with accounting and finance backgrounds are left scratching their heads because they don’t understand the nuances of nonprofit accounting. A great example of recoupment is the Certified Community Behavioral Health Clinics (CCBHCs) that were created through Section 223 of the Protecting Access to Medicare Act. The CCBHC implementation

began in 2017 as a two-year demonstration program consisting of 13 providers in New York State. CCBHCs have a uniform payment amount per visit and day, regardless of the amount of services or intensity of services used by an individual that day, and the providers were all issued their respective fixed rates. After the implementation period, the providers were notified of a substantial retroactive decrease in the rate, and that the monies paid previously would be recouped. This notification had a negative effect on the bottom line of all 13 providers in 2019. It also proved the nonprofit 2017–2019 budgets incorrect. It is not all negative and take-backs, though. For instance, New York City understands that the services being provided are often not being paid for in full. In March 2019, the City of New York Health and Human Services, in collaboration with providers and the Nonprofit Resiliency Committee, developed a Cost Policies and Procedures Manual that standardizes indirect cost rate calculation and claiming policies for New York City Health and Human Services contracts. In many situations, providers will get reimbursed for indirect costs. Management must educate their Board members so that they understand that there is a lot of gray area from service to service, and from budget line item to budget line item. Teaching your Board about nonprofit accounting is a key way to get more brains from different industries and backgrounds all working toward improving the financial viability of your organization.

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• New York City Indirect Cost Reimbursement — Per the March 2019 Cost Policies and Procedures Manual, we are entitled to a 12% indirect cost rate reimbursement for eligible New York City Health and Human Services contracts. Our calculation is that we will receive $180,000 of revenue for our indirect costs in 2020. Another way to educate your Board is through trainings. Boards often go to trainings focused on governance and leadership, but those are general trainings for all Boards. We recommend a training session tailored specifically to your programs, explaining how they operate and how to expect the unexpected. Management can run the training or hire outside professionals to do so. Board members do not serve forever, and new suitable members are recruited, nominated and voted upon to fill vacancies. Adding education to the onboarding of new Board members is a great strategy. If you previously provided your Board with a tailored training, film it and show the film to new members as part of their orientation. Although it can be difficult to find an expert in nonprofit accounting for your Board of Directors, educating your Board with plenty of MD&A and annual trainings is a great way to start turning them into the experts you are seeking. Once your Board members understand the nonprofit accounting of your programs, the knowledge they provide will include a better perspective, which will enable your organization to further its mission.

The importance of adding management discussion and analysis (MD&A) to everything with numbers presented to the Board cannot be stressed enough. MD&A gives management a chance to comment on each revenue stream. This commentary should explain the gray areas and can explain the best- and worst-case scenarios of a budget. The MD&A can be taken a step further and address future goals and approaches. The more the MD&A is put in front of the Board, the more times they will be able to read it and educate themselves about how the different revenue streams of the organization operate. For the three scenarios listed above, this is a sample MD&A: • Human services organization residential unit multiplied by rate revenue stream —The program has had consistent attendance and limited vacancy during the past three years, leading the organization to expect near full attendance in 2020. The current rate is a prospective rate; the final rate is expected in June 2020. Because of food component cuts, the final rate is expected to be lower or remain the same (offset by a cost of living adjustment). This projects program revenue to be at best $1.5 million, and at worst $1.25 million. • CCBHC recoupment —We received notification that the CCBHC fixed rate is retroactively reduced by 20%. This will result in a liability for 2017–2019 revenue received of $2 million (20% of $10 million). In addition, 2020 revenue is projected to be 20% lower than the prior year.

Matthew Castellano, CPA , Senior Manager in the firm’s Nonprofit, Government & Healthcare Group, has extensive experience planning and con- ducting operational and financial audits for a variety of nonprofit organizations, including human service organizations, charitable organizations and trade organizations, as well as educational institutions. He also has extensive experi- ence in audits pursuant to Uniform Guidance (Single Audits), as well as audits of the NYS Consolidated Fiscal Report, defined benefit and employee benefit plans, and Housing Development Fund Corporations (HDFCs). Matthew can be reached via email at mcastellano@markspaneth.com or at 212.201.2260.

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Footnote Disclosure Overload JOHN D’AMICO, CPA PARTNER, PROFESSIONAL STANDARDS GROUP

T he terms “footnote disclosure years by various constituent groups to describe their concerns about the complexity of Financial Accounting Standards Board (FASB) accounting rules and the resulting profusion of footnote disclosures. By definition, financial statements are backward looking. The statement of financial position (balance sheet) shows you the values as of a certain point in time, known as the organization’s year end, whereas the statement of activities (income statement) and cash flows shows how the organization performed over a period of time, typically a year. Footnote disclosures describe how the numbers in the state- ment of financial position, statement of activities and cash flow statements were determined and provide a sense of where the organization is going. Financial statements are required to provide full disclosure, including future contingencies and commitments. The overload” and “standards overload” have been used off and on for over 20

footnotes complete the organization’s obligation to disclose this information.

Over the years, the FASB has had several projects to “streamline disclosures” and a “Disclosure Framework” project to improve the effectiveness of disclosures in notes to financial statements by clearly communicating the most important information to users of each entity’s financial statements. Although reducing the volume of notes to financial statements was not the primary focus, the FASB hopes that a sharper focus on important information will result in reduced volume in most cases. However, it seems that these projects have been somewhat forgotten for nonprofits. The extensive footnote disclosures have in many ways been a detriment to the main reason why there are footnote disclosures in the first place: to inform the stakeholders of relevant information about the organization. As a result, most stakeholders do not fully read the notes because of their length. Important information can easily be buried, and more footnotes have resulted in additional costs to prepare the annual financial statements both internally and externally.

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• a new liquidity and availability of resources footnote; • a requirement to disclose the amounts and purposes of governing board designations that result in self- imposed limits on the use of resources at the end of their reporting period; • an enhanced qualitative description of the method(s) used to allocate costs among program and support functions; and • additional disclosures for endowment funds that are under water. DISCLOSURES REQUIRED BY ASU 2018-08 CLARIFYING THE SCOPE AND THE ACCOUNTING GUIDANCE FOR CONTRIBUTIONS RECEIVED AND MADE FASB issued this ASU because of difficulty and diversity in practice among not-for-profits with the following: • characterizing grants and similar contracts with government agencies and others as reciprocal trans- actions (exchanges) or nonreciprocal transactions (contributions); or for • distinguishing between conditional and unconditional contributions. A grant can either be an exchange transaction or a contribution, depending on the grant agreement. If a grantor (government or foundation) is not receiving direct commensurate value for the funds provided/ promised, then the grant is a contribution and this ASU is applicable regarding how the revenue is recog- nized. If the grant document has a barrier to overcome before the revenue can be recognized and a right of return/release from obligation, it is considered a condi- tional contribution until the conditions are met. If the grantor is receiving direct commensurate value for the funds provided/promised, then the grant is an exchange transaction and ASU 2014-09 Revenue from Contracts with Customers (ASC Topic 606) is applicable regarding how the revenue is recognized. (See below.) Conditional government and foundation grants will result in an additional footnote disclosure. For conditional promises to give, an organization needs to disclose the following:

ADDITIONAL DISCLOSURES FOR NONPROFIT ORGANIZATIONS

Recently, generally accepted accounting principles (GAAP) have become more complex, requiring additional and more elaborate disclosures, especially for nonprofit organizations. It is not uncommon to have from 10 to more than 20 pages of footnote disclosures for a nonprofit organization, and the recently issued Accounting Standards Updates (ASU) issued by the FASB will signifi- cantly increase the footnote disclosures for nonprofits. Recent ASUs that require significant additional disclosures for nonprofit organizations are as follows: • ASU 2016-14 Not-for-Profit Entities (Accounting Standards Codification (ASC) Topic 958)—Was effective for fiscal years beginning after December 15, 2017 (December 31, 2018 year-ends) • ASU 2018-08 Clarifying the Scope and the Account- ing Guidance for Contributions Received and Made — Effective for fiscal years beginning after December 15, 2018 (December 31, 2019 year-ends) • ASU 2014-09 Revenue from Contracts with Customers (ASC Topic 606) —Effective for fiscal years beginning after December 15, 2018 (December 31, 2019 year-ends) • ASU 2016-02 Leases (ASC Topic 842)—Will be effective for fiscal years beginning after December 15, 2020 (December 31, 2021 year-ends) • FASB is working on a project regarding gifts-in-kind (donated nonfinancial assets) expected to be issued in the first quarter of 2020. DISCLOSURES REQUIRED BY ASU 2016-14 NOT-FOR-PROFIT ENTITIES (ASC TOPIC 958) ASU 2016-14 Not-for-Profit Entities was issued to make improvements for the net asset classifications, to provide information regarding liquidity and availability of resources, and to remove inconsistencies in financial reporting for better comparability among nonprofit organizations. It provides the following: Proposed Gifts-in-Kind Exposure Draft with an addi- tional footnote disclosure:

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• the total of the amounts promised; and • a description and amount of each group of promises having similar characteristics, such as amounts of promises conditioned on establishing new programs, completing a new building, and raising matching gifts by a specified date. For unconditional promises to give, an organization needs to disclose the following: • the amount of promises to give that are receivable in less than one year, in one to five years, and in more than five years; • the amount of the allowance for uncollectible promises to give; and • the discount rate to present value for the receiv- ables due more than one year. DISCLOSURES REQUIRED BY ASU 2014-09 REVENUE FROM CONTRACTS WITH CUSTOMERS (ASC TOPIC 606) The core principle of Topic 606 is that an entity should recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The objective of the disclosure requirements in Topic 606 is for an entity to disclose sufficient information to enable users of the financial statements to understand the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. The nature and extent of this information differs between public and nonpublic entities (nonprofits are considered to be public entities if they issue public debt or are a conduit debt obligor for debt that is not privately placed). This ASU requires an entity to provide information about the following: • revenue recognized from contracts with customers, including the disaggregation of revenue into appropriate categories; • contract balances, including the opening and closing balances of receivables, contract assets and contract liabilities;

• performance obligations, including when the entity typically satisfies its performance obligations and the transaction price that is allocated to the remaining performance obligations in a contract; and • significant judgments, and changes in judgments, made in applying the requirements to those contracts. Additionally, an entity is required to provide quantitative and/or qualitative information about assets recognized from the costs to obtain or fulfill a contract with a customer. DISCLOSURES REQUIRED BY ASU 2016-02 LEASES (ASC TOPIC 842) The FASB issued this update to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrange- ments. The main difference between previous GAAP and Topic 842 is the recognition of lease assets and lease liabilities classified as operating leases under previous GAAP. There are specific required disclosures as follows: a) Information about the nature of its leases, including the following: 1. a general description of those leases; 2. the basis and terms and conditions on which vari- able lease payments are determined; 3. the existence and terms and conditions of options to extend or terminate the lease; 4. the existence and terms and conditions of residual value guarantees provided by the lessee; and 5. the restrictions or covenants imposed by leases (such as incurring additional financial obligations). b) A lessee should provide narrative disclosure about the options that are recognized as part of its right-of- use assets and lease liabilities and those that are not. c) A lessee should identify the information relating to subleases included in the disclosures provided in (a.1) through (a.5), as applicable. d) Information about leases that have not yet commenced but that create significant rights and obligations for the lessee, including the nature of

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any involvement with the construction or design of the underlying asset. e) Information about significant assumptions and judgments made in applying the requirements of this topic, which may include the following: 1. the determination of whether a contract contains a lease; 2. the allocation of the consideration in a contract between lease and nonlease components; and 3. the determination of the discount rate for the lease. DISCLOSURE REQUIREMENTS FOR THE GIFTS-IN-KIND PROPOSED EXPOSURE DRAFT The objective of this project is to increase transparency about contributed nonfinancial assets through enhance- ments to the presentation and additional disclosures. Disaggregation of contributions of nonfinancial assets received by category in the footnotes, and for each category: • qualitative information about whether contributed nonfinancial assets were monetized or used; if used, a description of the specific programs or activities in which they were used; • a description of any associated donor restrictions; and • the principal market (or most advantageous market) There are specific required disclosures as follows:

used in the valuation (in addition to disclosures already required under Topic 820).

IS RELIEF FINALLY IN SIGHT?

The FASB has again realized that improvements are required in what needs to be disclosed in financial state- ments. In 2018, two ASUs (ASU 2018-13 and 2018-14) were issued that will eliminate certain disclosures in the general-purpose financial statements for fair value mea- surement and for organizations that have defined benefit plans. These ASUs will be effective for financial periods ending December 31, 2020, and December 31, 2021, respectively. Both footnote disclosures are extremely lengthy, so these ASUs are a step in the right direction. Also, in August 2018 the FASB issued Statement of Financial Accounting Concepts No. 8 Conceptual Framework for Financial Reporting as amended. This Concepts Statement made amendments to Chapter 3 Qualitative Characteristics of Useful Financial Information . It describes what information the FASB should consider in the notes by describing the purpose of the notes, the nature of appropriate content and general limitations. Concepts Statements are not part of the FASB Accounting Standards Codification. Rather, Concepts Statements describe concepts that will underlie guidance on future financial accounting practices and in due course will serve as a basis for evaluating existing guidance and practices.

John D’Amico, CPA , Partner in the Professional Standards Group, provides quality control services to the firm’s Nonprofit, Government & Healthcare Group. He has more than 25 years’ experience providing accounting and audit services to nonprofit organizations and higher education and governmental entities, and brings extensive knowledge of nonprofit accounting and expertise in the performance of Single Audits. John can be reached via email at jdamico@markspaneth.com or at 212.710.1808.

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A Guide to Proper Reporting and Valuation of In-Kind Contributions JOSEPH KANJAMALA, CPA, CGMA PARTNER, NONPROFIT, GOVERNMENT & HEALTHCARE GROUP

BACKGROUND I n addition to financial contributions, in-kind contributions. These donations could be in the form of a contributed service, such as free legal service, or gifts-in-kind such as a piece of furniture or pharmaceuticals. The gifts-in-kind could be tangible, as in pharma- ceuticals, or intangible, such as a guarantee or below-market interest rate. not-for-profits (NFPs) frequently receive donations of goods and services, or

need to record them on an NFP’s financial statements. Stakeholders may argue that recording these items will merely gross up revenue and expenses with no effect on the operating results. However, not recording these items can distort an NFP’s financial statements, understating the organization’s revenue and expenses, and does not allow for true comparison between similar organizations. As such, NFPs are required to report these contributions. U.S. generally accepted accounting principles (US GAAP) require an NFP to report the fair value of the in-kind contribution on its financials on the date when the contribution is made known to the NFP, irrespec- tive of the actual date of receipt. To be recognized as a contribution, the goods or service must create or enhance a nonfinancial asset and/or require a

There is a common misconception among stakeholders that because in-kind contributions are free, there is no

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Fair value is a market-based measurement and not an entity-specific measurement.

specialized skill that the contributor has and would typically need to be purchased if not provided through contribution. However, even if these criteria are met, if the goods or services are not in a condition that allows for their use when they are received, if they are for the benefit of another organization, or if in an agency transaction it is difficult to determine their value, then the revenue and expenses recognition could be inappropriate. The value of the in-kind contribution is recorded as a contribution in the operating revenue and support section of the statement of activities and as an expense in the statement of functional expenses as a natural expense line item. If the in-kind contribution is a capitalizable item, such as real estate, then an asset account is recorded instead of expenses. In no instances can the contribution offset the expense or assets. If the donor restricts the in-kind contribution, then it should be recorded as a donor-restricted contribution.

requires an NFP to value in-kind contributions at fair value. FASB ASC 820 defines fair value and establishes a framework for measurement of fair value. The fair value measurement assumes that the transaction to sell the asset or transfer the liability takes place either in the principal market for the asset or liability or, in the absence of a principal market, the most advanta- geous market for the asset or liability. Fair value is defined by Topic 820, Fair Value Measure- ment, as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transac- tion between market participants at the measurement date.” Fair value is a market-based measurement and not an entity-specific measurement. The purpose of fair value measurement is to estimate the price, which requires assumptions (including assumptions about risk) that market participants would use. The various techniques used for fair value measurement are market, cost and income approaches. Items such as in-kind contributions tend to follow the market approach for valuation, though there are exceptions.

Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 958-605

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RECORDING AND VALUATION OF COMMON IN-KIND CONTRIBUTION ITEMS

Labor Statistics and/or private organizations such as Independent Sector. • Board Member Services When Board members of an NFP contribute their time to its governance and mission, such services are valuable but do not need to be recorded as an in-kind contribution. However, Board members frequently have highly specialized professional skills and may use these skills for projects that would normally be considered outside the scope of normal Board duties. For example, a Board member who is an attorney is engaged, pro bono, to defend the NFP in a lawsuit. The time spent by this Board member is a contributed professional service, and thus the fair value must be recorded as a contribution. • Contribution of Land and Buildings or Other Fixed Assets When the legal titles to land and buildings or other fixed assets are transferred to an NFP, the NFP records the fair market value of the asset with a corresponding credit to contribution without donor adoption of ASU No. 2016-14, NFPs had a choice to record the in-kind contribution of land and buildings and other fixed assets as contributions with donor restrictions and then release the donor-restricted net assets over the years when the asset was depreciated. With the adoption of ASU 2016-14, in the absence of explicit donor restrictions, NFPs would be required to use the “placed in service” approach and can no longer imply a time restriction and release it over the life of the fixed assets.) • Clothing The fair market value of donated clothing is estimated based on the cost incurred to bring the clothing to a saleable condition. An NFP may incur costs to main- tain donation bins, transport the donated clothing to a central warehouse for sorting, cleaning, folding and packing, transporting the clothing to a thrift store for sale, the salary and related costs of the people involved in preparing the clothing for sale, etc. Such costs are used to arrive at the fair value of the donated clothing inventory. • Donated Pharmaceuticals NFPs that receive and report donated pharmaceu- ticals are highly monitored by the Internal Revenue Service, the attorneys general of various states and other regulatory bodies. The fair value of donated restriction. The fair market value is estimated through an appraisal of the asset. (Before the

• Donated Auction Item When an NFP receives an item to be sold at a gala or an auction, the NFP must record that contribution at fair value on the date on which the contribution is made known to the NFP. Later, if the item is sold at the auction at a price different from the fair value, then the NFP must recognize an adjustment to the original contribution amount recorded. • Public Service Announcement (PSA) Often, an NFP receives free airtime, media space or advertising on a television network, radio station, newspaper or website—commonly referred to as a public service announcement (PSA). PSAs provide future economic benefits to an NFP in the form of potential contributions, membership fees, promotion of the NFP’s mission, etc. Therefore, the fair market value of the PSA must be estimated and recorded in the NFP’s financial statements. The provider of the PSA can give a detailed listing of the PSA with the price-per-minute, which can be used for estimating the fair value. • Free Usage of Space When an NFP is allowed to rent a space free of charge, or at a rental rate that is below the fair rent for the space, the NFP must record an in-kind contribution estimated at the fair rent or the difference between the fair rent and the below-market rent that the NFP is paying. If the lease involves multiple years, the NFP must record the net present value for the entire term of the arrangement in year one as a donor-restricted contribution and pledges receivable. The restriction would be released over the term of the lease agree- ment. In a multiyear lease, the fair value of the lease recorded in the books cannot exceed the fair value of the property. For example, if the total lease payments over the term of the lease equal $2 million where the fair market value of the property is $1.8 million, the contribution recorded in the first year would be limited to $1.8 million. • Donated Professional Services When professionals such as accountants, lawyers, doctors, carpenters, nurses, teachers and other pro- fessionals provide pro bono services to an NFP, the fair market value of such services must be estimated. This can be achieved by using the average hourly rates for such services as published by the U.S. Bureau of

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pharmaceuticals is generally estimated using prices published in professional reference materials such as Thomson Reuters “Red Book,” an industry-recognized information and pricing reference guide for prescrip- tion and over-the-counter drug products in the United States. However, different pricing models exist, and organizations have to choose a model to estimate the fair value of pharmaceutical contributions. “Red Book” contains the Average Wholesale Price (AWP), Wholesale Acquisition Cost (WAC), Direct Price (DP), Suggested Retail Price (SRP) and Federal Upper Limit (FUL). AWP, WAC and FUL are the most common pricing models used by NFPs. AWP is the average price for medications offered at the wholesale level. WAC is an estimate of the manufacturer’s list price for a drug to wholesalers or direct purchasers but does not include discounts or rebates. FUL is the maximum reimbursement amount allowed for certain drugs under Medicare. Pricing under AWP is the highest, followed by WAC and FUL. There are several alliances of pharmaceutical com- panies and NFPs, such as Partnership for Quality Medical Donations (PQMD), Accord and others that have attempted to establish guidelines for the valuation of donated pharmaceuticals. Because the practice followed for the valuation of contributed pharmaceuticals can vary, in some cases, it has been questionable and controversial. For instance, the state of California has sued several charities over pharmaceutical valuation methodologies in which the state took the position that the principal or most advantageous market is the foreign market where the beneficiaries are, rather than the U.S. market where the pharmaceuticals are mostly transacted. The California legislature went so far as to establish their own GAAP on valuation of contributed phar- maceuticals, which was vetoed by the Governor. • Collection Items Examples of collection items are pictures, antiques, stamps, coins, manuscripts, etc. that are protected, preserved and held for public exhibition, education or research or in furtherance of public service rather than financial gain. When an NFP receives an in-kind contribution of collection items, whether to record a contribution depends on the NFP’s accounting policy on collection. In general, if the accounting policy is to

capitalize collections, the NFP records an asset with corresponding credit to a contribution. However, if the policy is not to capitalize collections, then a contribution is not recorded. • Donated Stock The fair value of donated stock is recorded as a con- tribution on the date on which the donation is made known to the NFP at its value on that date. If there is a change in the fair value of the stock on the date on which the NFP receives the stock, the fair value orig- inally recorded needs to be adjusted to reflect the fair value on the date of receipt. When the NFP sells the donated stock later, a gain or loss on sale would be recorded, which is the difference between the sale price and fair value already recorded. Under ASC 230-45-21A, when an NFP converts donated stock nearly immediately into cash, then the sale proceeds must be considered as an operating activity for cash flow purposes. However, if the donated stock is restricted for a long-term purpose, then the proceeds from the sale of the donated stock are considered as a financing activity for cash flow purposes. • Bargain Purchase A contribution may occur as part of an exchange transaction. For example, an NFP land trust com- pensates a resort to set aside part of its land from development. The appraised value of the land is $3 million, but the resort agrees to accept only $1 million from the NFP. That difference between $3 million and $1 million is considered a contribution. • Guarantees Because of an NFP’s credit history or financial standing, it may have difficulty obtaining a loan or line of credit from a financial institution. In such a situation, the financial institution might receive a guarantee for the NFP’s loan from an unaffiliated for-profit or not-for-profit, without the NFP providing commensurate consideration. In a transaction like this, the NFP has received an intangible contribution, which is the difference between the stated interest on the loan agreement and the market interest rate that would have been charged if the NFP had entered into the loan without a guarantee. The NFP records an interest expense for the differ- ential with a corresponding credit to contribution. There is also a conditional contribution attributable

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to this transaction, which is the guarantor’s prom- ise to pay off the debt upon the NFP’s default. The NFP records a contribution if the NFP defaults on the debt and the guarantor pays off the debt. If the guarantor is a related party or company under common control, then the interest is not imputed. • Below-Market Interest Loans When an NFP receives interest-free loans or loans at interest below prevailing market rates, an in-kind contribution is generated and the NFP must impute interest on such loans. The value of the in-kind contribution is the difference between the stated interest rate in the loan agreement and the prevailing market interest rates, and the NFP records an interest expense with a corresponding credit to contribution. When the interest-free loan is long term, the presumption is that a portion of the long- term debt is imputed interest payable. Accordingly, in year one, the NFP records a portion of the debt as loan payable and the balance as imputed interest payable. In subsequent years, the imputed interest payable is amortized, and by the due date of the debt, the loan payable will be shown at the face value of the loan. If the interest-free loan is between a par- ent and a subsidy, imputing the interest is optional. RECENT DEVELOPMENTS The current disclosure requirements include the nature, extent, amount and programs or activities for which the contributed services were used, and any restriction imposed by donors on the use of contributed assets. On February 10, 2020, FASB issued a proposed ASU

intended to improve transparency around how NFPs present and disclose gifts-in-kind and require NFPs to have additional presentation and disclosure require- ments as outlined below.

PROPOSED PRESENTATION REQUIREMENTS

Not-for-profit organizations would be required to present contributed nonfinancial assets as a separate line item in the statement of activities.

PROPOSED DISCLOSURE REQUIREMENTS:

a) Disaggregate the gifts-in-kind by category. b) For each category, provide qualitative information on whether the gifts-in-kind were or are intended to be either monetized or used during the reporting period and future periods. If used, include a description of programs in which these gifts-in-kind were or are intended to be used. c) Description of donor restrictions on the gifts-in-kind, if any. d) The valuation technique used to arrive at fair market value, including the principal market or most advan- tageous market if there is no principal market. The comment period ends on April 10, 2020. The professionals in Marks Paneth’s Nonprofit, Government & Healthcare Group will continue to monitor updates to the financial reporting of in-kind contributions to help nonprofits adapt to and comply with changing disclo- sure requirements.

Joseph J. Kanjamala, CPA, CGMA , Partner in the firm’s Nonprofit, Government & Healthcare Group, has more than 20 years of public accounting experience. He has developed deep skills providing audit services to nonprofit organizations and has served numerous charitable organizations, private foundations and educational institutions. Joe can be reached via email at jkanjamala@markspaneth.com or at 212.503.8952.

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Not-for-Profit Raffles: Don’t Gamble with Federal and State Requirements MAGDALENA M. CZERNIAWSKI TAX PARTNER, NONPROFIT, GOVERNMENT & HEALTHCARE GROUP ROBERT LYONS TAX DIRECTOR, NONPROFIT, GOVERNMENT & HEALTHCARE GROUP

W i th an ever-increasing need for funding and, in some cases, a decrease in charitable con- tributions, not-for-profits are turning to a variety of other alternatives when seeking to fund their mission. Charitable gambling activities, whether utilized as a stand-alone activity or part of a larger event, such as a gala, are becoming more popular with many organizations. Raffles are one of the most common examples of such activities, and the one that we will examine more closely in this article. While raffles are often an effec- tive way to raise funds, not-for-profits that undertake raffle activities should be cautious and ensure they understand all federal and state filing requirements triggered by the charitable gambling activity. Not following the proper protocol can threaten an organization’s

exempt status and/or create issues at the state and federal levels.

It is important to first be aware that gambling activities can trigger additional reporting requirements for non- profits. Determining whether an activity rises to the level of gambling is more of a state issue than a federal issue, other than proper reporting on Schedule G Part III (Gam- ing Activities). Charitable gambling is more commonly referred to as “games of chance,” though in this article, we will refer to raffles specifically. In general, “Gambling is defined as the wagering, betting, or laying of money or other thing of value on the transpiring of any event what- soever, whether it be on the result of a game of chance or on a contest of skill, strength, speed, or endurance, whereby one party gains and the other loses something for nothing, whether the parties betting be the actors in the event or which their wager is laid or not.” 1

FEDERAL PERSPECTIVE

With regard to not-for-profit organizations, “games of chance” are generally restricted to raffles, lotteries, bin-

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