Valuation of Gifts in Kind Explained: Part 1
Valuation of gifts in kind is not hard, if you know what you're doing.
But that’s the problem, isn’t it? Very few organizations with an aid distribution program feel confident in how they approach the valuation of in-kind gifts. This problem is exacerbated by a general lack of understanding in how accounting principles are applied to donated goods and by non-authoritative, third-party voices all espousing their opinions – of which there are many and conflicting opinions to choose from – on how other organizations should approach the fair market valuation of donated goods. It’s all just noise. It’s loud, distracting, but most importantly, it’s not helpful.
Instead, the focus should be on what is known, understood, and foundational to fair market value so that nonprofits can gain confidence in their approach to valuing their donated goods.
Each Nonprofit is Responsible for Its Own Form 990
We all learned in school that sneaking a peek at the work of the smart kids sitting next to you and putting their answers down as your own is frowned upon. Sure, you could study with others, you could brainstorm with others, but only you could take your test and your test score belongs only to you. It taught us that we must each be responsible for our own work and the ensuing results. The same goes for how a nonprofit assesses the fair market value of donated goods.
Each nonprofit is responsible for its own 990 reporting no matter what other nonprofits or non-authoritative third-parties may be saying or doing. In other words, when state and federal regulators look at a nonprofit’s 990, no other organization will be held liable for the information therein.
Let’s look at this scenario:
Two charities receive a donation of the exact same product in the exact same condition and in the exact same quantity. Using accounting principles for fair market valuation (which we will look at in the next section), the board of directors, executive staff, and CPA for each organization derive an approach to assess the fair market value of the donated product.
Charity A assesses the unit value to be $3. Charity B assesses the unit value to be $4. Which one is right?
The answer is both – or neither. The problem is that the question “which one is right?” is the wrong question to be asking. The idea of right and wrong does not apply because there is no definitive “right” answer to fair market value. That is why fair market value is also known as an appraisal. The right question to be asking is, “Did each organization follow established accounting principles, and are they confident in their ability to defend their approach?” The appraisal industry teaches that fair market value is more about procedure and controls in the use of accounting principles than it is about the actual estimate.
So, what are these mysterious accounting principles that nonprofits should use for the fair market valuation of donated goods?
Accounting Principles Unveiled
First, a quick lay of the land.
The U.S. Securities and Exchange Commission (SEC) adopted the Generally Accepted Accounting Principles (GAAP) as the foundation for accounting practices in the United States.
The Financial Accounting Standards Board (FASB), a private, nonprofit organization, is designated by the SEC as the responsible organization for setting accounting standards for public companies.
The American Institute of Certified Public Accountants (AICPA) sets ethical and auditing standards for U.S. certified accountants performing audits of U.S. entities.
What follows next is so simple, it will make you wonder what any fuss is about.
The accounting industry provides guidance on how to determine fair market value. Accounting Standards Codification (ASC) Topic 958, Not-for-Profit Entities addresses revenue recognition for nonprofit entities and states that “contributions received shall be recognized as revenues or gains in the period received and as assets, decreases of liabilities, or expenses depending on the form of the benefits received. Contributions received shall be measured at their fair values.” This means that any charity receiving a contribution of donated goods must account for them as revenue at their fair value.
Accounting Standards Codification (ASC) Topic 820, Fair Value Measurement provides guidance for how entities should define, measure, and disclose fair value in their financial statements.
According to ASC 820, fair market value is defined as the price that would be received to sell an asset in an orderly transaction between market participants at the measurement date.
Let’s break that down.
- Price: The fair value of an item is the dollar amount you would receive if you sold it. This is called the exit price.
- Orderly transaction: An orderly transaction assumes that the item would exchange between a willing buyer and a willing seller, each having reasonable knowledge of all relevant facts, neither under compulsion to buy or sell, and with equity to both.
- Market participants: Fair value assumes that the transaction to sell an item occurs in the principal market for that item or, in the absence of a principal market, the most advantageous market. This standard also assumes the highest and best use of the item.
- Transaction date: The fair value of an item is assessed when the transaction takes place. Any change in the market value of the item prior to, or following the transaction, has no bearing on the value of the item at the time of transaction.
That’s it. It is that simple. These are the principles adopted by the SEC, codified and explained by the FASB, and enforced by the AICPA and state and federal regulators. The principles themselves are fairly easy to understand, yet sometimes their application in some situations can be a little complex. That is why you should read the next article. Oh, and DEFINITELY listen to everything your CPA says.
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