Accounting and Financial Reporting for Irrevocable Split-Interest Agreements

June 2, 2015 Comments Due: September 18, 2015 Proposed Statement of the Governmental Accounting Standards Board Accounting and Financial Reporting for Irrevocable Split-Interest Agreements This Exposure Draft of a proposed Statement of Governmental Accounting Standards is issued by the Board for public comment. Written comments should be addressed to: Director of Research and Technical Activities Project No. 3-26E

ACCOUNTING AND FINANCIAL REPORTING FOR IRREVOCABLE SPLIT-INTEREST AGREEMENTS WRITTEN COMMENTS Deadline for submitting written comments: September 18, 2015 Requirements for written comments. Comments should be addressed to the Director of Research and Technical Activities, Project No. 3-26E, and emailed to director@gasb.org or mailed to the address below. OTHER INFORMATION Public hearing. The Board has not scheduled a public hearing on the issues addressed in this Exposure Draft. Public files. Written comments will become part of the Board s public file and are posted on the GASB s website. Orders. This Exposure Draft may be downloaded from the GASB s website at www.gasb.org. For information on prices for printed copies, please contact the Order Department at the following address: Governmental Accounting Standards Board 401 Merritt 7 PO Box 5116 Norwalk, CT 06856-5116 Telephone Orders: 1-800-748-0659 Please ask for our Product Code No. GE96. GASB publications also may be ordered at www.gasb.org. Copyright 2015 by Financial Accounting Foundation. All rights reserved. Permission is granted to make copies of this work provided that such copies are for personal or intraorganizational use only and are not sold or disseminated and provided further that each copy bears the following credit line: Copyright 2015 by Financial Accounting Foundation. All rights reserved. Used by permission. i

Notice to Recipients of This Exposure Draft The Governmental Accounting Standards Board (GASB) is responsible for establishing and improving standards of state and local governmental accounting and financial reporting to provide useful information to users of financial reports and to educate stakeholders including issuers, auditors, and users of those financial reports on how to most effectively understand and implement those standards. The due process procedures that we follow before issuing our standards and other communications are designed to encourage broad public participation in the standardssetting process. As part of that due process, we are issuing this Exposure Draft setting forth a proposed Statement addressing accounting and financial reporting issues related to irrevocable split-interest agreements. We invite your comments on all matters in this proposed Statement. Because this proposed Statement may be modified before it is issued as a final Statement, it is important that you comment on any aspects with which you agree as well as any with which you disagree. To facilitate our analysis of comment letters, it would be helpful if you explain the reasons for your views, including alternatives that you believe we should consider. All responses are distributed to the Board and to staff members assigned to this project, and all comments are considered during the Board s deliberations leading to a final Statement. In deciding on changes in accounting and financial reporting standards, the GASB also takes into consideration the costs of preparing and reporting the information and its benefits to users of financial statements. When the Board is satisfied that all alternatives have been adequately considered, and modifications have been made as considered appropriate, a vote is taken on the Statement. A majority vote is required for adoption. ii

Summary The objective of this proposed Statement is to improve accounting and financial reporting for irrevocable split-interest agreements by providing recognition and measurement guidance for circumstances in which a government is a beneficiary of the agreement. Split-interest agreements are a specific type of giving arrangement used by donors to provide resources to two or more beneficiaries, including governments. Split-interest agreements can be created through trusts or equivalent arrangements under which a donor transfers resources to an intermediary to hold and administer for the benefit of the government and at least one other beneficiary. Examples of these types of arrangements include charitable lead trusts, charitable remainder trusts, charitable annuity gifts, and lifeinterests in real estate. This proposed Statement would require that a government that receives resources pursuant to an irrevocable split-interest agreement recognize assets, liabilities, and deferred inflows of resources. Furthermore, this proposed Statement would require that a government recognize as assets beneficial interests in irrevocable split-interest agreements that are administered by a third party, if those beneficial interests are under the control of the government and embody present service capacity. The requirements of this proposed Statement would be effective for financial statements for periods beginning after December 15, 2016, and would be applied retrospectively. Earlier application would be encouraged. How the Changes in This Proposed Statement Would Improve Financial Reporting The requirements of this proposed Statement would provide recognition and measurement guidance for certain transactions and balances for which little authoritative guidance currently exists. Consequently, it would enhance comparability of financial statements among governments by providing specific accounting and financial reporting guidance for irrevocable split-interest agreements in which a government is a beneficiary. This proposed Statement also would enhance the decision-usefulness of general purpose external financial reports and their value for assessing accountability by improving transparency of the resources available for the government to carry out its mission. Unless otherwise specified, pronouncements of the GASB apply to financial reports of all state and local governmental entities, including general purpose governments; public benefit corporations and authorities; public employee retirement systems; and public utilities, hospitals and other healthcare providers, and colleges and universities. Paragraph 3 discusses the applicability of this Statement. iii

Proposed Statement of the Governmental Accounting Standards Board Accounting and Financial Reporting for Irrevocable Split-Interest Agreements June 2, 2015 CONTENTS Paragraph Numbers Introduction... 1 2 Standards of Governmental Accounting and Financial Reporting... 3 37 Scope and Applicability of This Statement... 3 5 Irrevocable Split-Interest Agreements... 6 9 A Government Is the Intermediary... 10 31 Recognition... 10 Asset Measurement... 11 A Government Is the Remainder Interest Beneficiary... 12 18 A Government Is the Lead Interest Beneficiary... 19 25 Life-Interests in Real Estate... 26 31 A Third Party Is the Intermediary... 32 37 Beneficial Interests... 32 Recognition... 33 34 Asset Recognition Criteria... 34 Measurement... 35 37 Effective Date and Transition... 38 Glossary... 39 Appendix A: Background... A1 A4 Appendix B: Basis for Conclusions... B1 B38 Appendix C: Codification Instructions... C1 C3 iv

Proposed Statement of the Governmental Accounting Standards Board Accounting and Financial Reporting for Irrevocable Split-Interest Agreements June 2, 2015 INTRODUCTION 1. The primary objective of this Statement is to improve accounting and financial reporting by providing recognition and measurement guidance for irrevocable splitinterest agreements. 1 Another objective of this Statement is to enhance the transparency and decision-usefulness of general purpose external financial reports, and their value for assessing accountability, by more clearly identifying resources that are available to a government. 2. Irrevocable split-interest agreements are a specific type of giving arrangement used by donors to provide resources to two or more beneficiaries, including governments. Examples of these types of arrangements include charitable lead trusts, charitable remainder trusts, charitable annuity gifts, and life-interests in real estate. STANDARDS OF GOVERNMENTAL ACCOUNTING AND FINANCIAL REPORTING Scope and Applicability of This Statement 3. This Statement establishes accounting and financial reporting standards for irrevocable split-interest agreements created through trusts or equivalent arrangements in which a donor irrevocably transfers its resources to an intermediary, which administers these resources for the unconditional benefit of a government and at least one other beneficiary. 2 The provisions of this Statement should be applied to financial statements of all state and local governments. 4. This Statement amends Statement No. 33, Accounting and Financial Reporting for Nonexchange Transactions, paragraph 5. In addition, this Statement supersedes Implementation Guide No. 2015-1, Question 7.72.11. 5. Guidance for irrevocable split-interest agreements in which the government is the intermediary (and a beneficiary) is provided in paragraphs 10 31. Specific guidance for life-interests in real estate is provided in paragraphs 26 31. Guidance for irrevocable split- 1 Terms defined in the glossary are printed in boldface type the first time they are used in this Statement. 2 The other beneficiary can be the donor, a relative of the donor, or other legal person or entity, including another government. 1

interest agreements in which a third party is the intermediary is provided in paragraphs 32 37. Irrevocable Split-Interest Agreements 6. An irrevocable split-interest agreement is one type of split-interest agreement used by donors to provide resources to two or more beneficiaries, including governments. Under an irrevocable split-interest agreement, the donor does not reserve, or confer to another person, the right to terminate the agreement at will and have the donated resources returned to the donor or a third party. Irrevocable split-interest agreements can be created through trusts or equivalent arrangements. 7. Provisions of individual arrangements can vary with respect to the entity acting as the intermediary, the assignment of benefits, the term of the agreement, and other general provisions. For example, some donors require that the government that has a beneficial interest also act as the intermediary in the irrevocable split-interest agreement. In other arrangements, the donor requires that a third party act as the intermediary. Irrevocable splitinterest agreements can provide resources to a government either throughout the term of the agreement in the form of periodic disbursements or as a final disbursement at the termination of the agreement. 8. A typical irrevocable split-interest agreement has two components: a lead interest and a remainder interest. The government may have the unconditional right to receive all or a portion of the resources remaining at the end of the irrevocable split-interest agreement s term (the remainder interest). Conversely, the goverment may have the right to all or a portion of the benefits of resources during the term of the agreement (the lead interest). In some irrevocable split-interest agreements, the amount of the disbursements to the lead interest beneficiary is pre-established as a specific amount (annuity). However, other irrevocable split-interest agreements define the periodic disbursements to the lead interest beneficiary as a variable amount, for example, as a specific percentage of the fair value of the assets measured at each disbursement date (unitrust). 9. An irrevocable split-interest agreement terminates after a specified number of years (period-certain term); upon the occurrence of a specified event, commonly the death of either the donor or the lead interest beneficiary (life-contingent term); or a combination of both terms. A Government Is the Intermediary Recognition 10. If a government is the intermediary and a beneficiary of an irrevocable split-interest agreement, the government should recognize assets, liabilities, and deferred inflows of resources when the agreement is executed and the government receives the resources. The government should recognize a liability for the portion of the donated assets that will be distributed to other beneficiaries. The government also should recognize a deferred inflow 2

of resources for the portion of the donated assets that will unconditionally benefit the government. Asset Measurement 11. Donated assets received pursuant to irrevocable split-interest agreements should be measured and, if applicable, remeasured in accordance with existing standards. For example, assets that meet the definition of an investment should be measured at fair value according to guidance provided in Statement No. 72, Fair Value Measurement and Application, as appropriate, and should be remeasured and reported at fair value at each reporting date. Investment income, including changes in the fair value of these investments, should follow the provisions of paragraph 13 of Statement No. 31, Accounting and Financial Reporting for Certain Investments and for External Investment Pools, as amended. A Government Is the Remainder Interest Beneficiary 12. When a government is the remainder interest beneficiary, it should recognize assets for resources received (as set forth in paragraph 11), a liability for the lead interest that is assigned to other beneficiaries, and a deferred inflow of resources for the government s unconditional interest. 13. The liability should be measured based on the stream of payments that is expected to be provided to other beneficiaries. This measurement should be based on an established valuation technique that takes into account the specific provisions of the agreement as well as the risks implied in the agreement. The assumptions that should be considered when measuring the liability include (a) the payment provisions of the agreement, (b) the estimated rate of return of the assets, (c) the mortality rate if the term is life-contingent, and (d) the discount rate if a present value technique is used. 14. If the amount recognized for the liability has not been discounted, disbursements to other beneficiaries should reduce the liability. If the amount recognized for the liability has been discounted, a portion of the disbursement should be allocated to the liability (thereby reducing the liability), and the remainder portion of the disbursement should be reported as interest expense/expenditure in resource flows statements. Related assets also should be reduced. 15. If a government makes disbursements in excess of the estimated liability prior to the termination of the agreement, the deferred inflow of resources should be reduced for the amount of each of the subsequent disbursements made to other beneficiaries until the termination of the agreement. 16. The liability generally should be reported at settlement amount throughout the term of the irrevocable split-interest agreement. However, if the term of the irrevocable splitinterest agreement is life-contingent, mortality adjustments should be considered and, if a significant adjustment is necessary at the financial reporting date, the adjustment should be 3

recognized in resource flows statements as an increase or reduction of revenue, as appropriate. 17. The deferred inflow of resources (for the remainder interest) should be measured initially as the difference between the assets associated with the irrevocable split-interest agreement and the liability to the other beneficiaries. The deferred inflow of resources should be remeasured at each financial reporting date as the difference between the carrying value of the assets associated with the irrevocable split-interest agreement and the carrying value of the related liability at that date. The changes resulting from the remeasurement of the deferred inflow of resources should be recognized in resource flows statements as an increase or reduction of revenue, as appropriate. 18. At the termination of the irrevocable split-interest agreement, the amount reported as a deferred inflow of resources that is associated with the agreement should be recognized as revenue. The elimination of any remaining liability should be recognized as a gain. A Government Is the Lead Interest Beneficiary 19. When a government is the lead interest beneficiary, it should recognize assets for resources received (as set forth in paragraph 11), a deferred inflow of resources for the government s unconditional interest, and a liability for the remainder interest that is assigned to other beneficiaries. As previously noted, irrevocable split-interest agreements in which a government is the lead interest beneficiary can be period-certain, life-contingent, or a combination of both. For example, an irrevocable split-interest agreement in which the term of the agreement is contingent upon the life of the donor could require that, at the death of the donor, the remainder interest be remitted to the donor s estate. 20. The deferred inflow of resources should be measured based on the stream of payments that is expected to be provided to the government. This measurement should be based on an established valuation technique that takes into account the specific provisions in the agreement as well as the risks implied in the agreement. The assumptions that should be considered when measuring the deferred inflow of resources include (a) the payment provisions of the agreement, (b) the estimated rate of return of the assets, (c) the mortality rate if the term is life-contingent, and (d) the discount rate if a present value technique is used. 21. If the amount recognized for the deferred inflow of resources has not been discounted, disbursements for the government s benefit should reduce the assets related to the irrevocable split-interest agreement and the related deferred inflow of resources. Revenue should be recognized for the disbursement from the irrevocable split-interest agreement to the government. If the amount recognized for the deferred inflow of resources has been discounted, a portion of the disbursement for the governmental benefit should be allocated to the related deferred inflow of resources (thereby reducing the deferred inflow of resources), and the remaining portion of the disbursement should be reported as interest revenue in resource flows statements. 4

22. If the disbursements for the benefit of the government exceed the estimated deferred inflow of resources prior to the termination of the agreement, the liability to other beneficiaries should be reduced for the amount of each of the subsequent disbursements until the termination of the agreement. 23. The deferred inflow of resources generally should be reported at settlement amount throughout the term of the split-interest agreement. However, if the term of the split-interest agreement is life-contingent, mortality risk adjustments should be considered, and if a significant adjustment is necessary at the measurement date, the adjustment should be recognized in resource flows statements as an increase or reduction of revenue, as appropriate. 24. The liability (for the remainder interest) should be measured initially as the difference between the assets associated with the irrevocable split-interest agreement and the related deferred inflow of resources. The liability should be remeasured at the financial reporting date as the difference between the carrying value of the assets associated with the irrevocable split-interest agreement and the carrying value of the related deferred inflow of resources at that date. The changes resulting from the remeasurement of the liability should be recognized in resource flows statements as an increase or reduction of revenue, as appropriate. 25. At the termination of the irrevocable split-interest agreement, when the assets are transferred to the remainder interest beneficiaries, the liability and any remaining deferred inflow of resources related to the agreement should be eliminated. Life-Interests in Real Estate 26. A life-interest in real estate is a specific type of irrevocable split-interest agreement in which the donor (or parties specified at inception by the donor) retains the right to use the donated asset, such as a residence. These agreements are life-contingent. 27. The donated asset should be recognized as either a capital asset or an investment, depending on the terms of the agreement and management s intent at the time of the donation. If the donated asset is recognized as a capital asset using the economic resources measurement focus, the asset should be measured at acquisition value and is subject to existing requirements for depreciation, impairment, and disclosure pertinent to a capital asset. If the donated asset is recognized as an investment, it should be measured and remeasured according to the guidance provided in Statement 72. The guidance provided in paragraphs 27 31 should be applied under both the current financial resources measurement focus and the economic resources measurement focus when the donated asset is reported as an investment. 28. A liability should be recognized if a government assumes obligations to sacrifice financial resources under the provisions of the agreement, such as for insurance, maintenance, or repairs of the donated asset. If a liability is recorded, it should be reduced as the government satisfies these obligations. 5

29. A related deferred inflow of resources should be recognized for the right retained by the donor to use the property. This deferred inflow of resources should be measured as the present value of estimated rent payments that would be received if the asset were occupied by a rent-paying tenant, taking into account the actuarial life expectancy of the beneficiaries. Revenue should be recognized by reducing this deferred inflow of resources in a systematic and rational manner over the estimated term of the agreement until the balance of the deferred inflow of resources is extinguished. 30. A separate deferred inflow of resources should be recognized for the remainder interest in the donated asset. This deferred inflow of resources should be measured as the difference between the donated asset and the related liability (if one is recognized), and the deferred inflow of resources recognized for the donor s retained right to use. 31. At the termination of the agreement, revenue should be recognized for the deferred inflow of resources representing the amount of the remainder interest. Furthermore, a gain should be recognized equal to any remaining deferred inflow of resources representing the donor s retained right to use. A Third Party Is the Intermediary Beneficial Interests 32. A beneficial interest is the right to a portion of the benefits from donated resources pursuant to a split-interest agreement in which the donor enters into a trust or equivalent arrangement and transfers the resources to an intermediary. When a third party is the intermediary, a government may share beneficial interests with at least one other beneficiary. Terms and provisions applicable to beneficial interests are described in paragraphs 6 9 of this Statement. Recognition 33. If a government is not the intermediary of an irrevocable split-interest agreement, an asset and a deferred inflow of resources should be recognized when the government becomes aware of the agreement and has sufficient information to measure the beneficial interest, provided that the criteria in paragraph 34 are met. Asset Recognition Criteria 34. Assets should be recognized for beneficial interests that meet all of the following criteria: a. The government is specified by name as beneficiary in the legal document underlying the donation. b. The government has an unconditional beneficial interest. c. The donation agreement is irrevocable. 6

d. The donor has not granted variance power to the intermediary with respect to the donated resources. e. The intermediary is not under the control of the donor. f. The government s ability to assign its beneficial interest is not subject to approval of the intermediary. g. The government s actual attempt to assign its beneficial interest does not invalidate the government s beneficial interest and thereby terminate the agreement. Measurement 35. The asset should be initially measured at fair value and remeasured at fair value at each financial reporting date. A deferred inflow of resources should be recognized for a beneficial interest recognized as an asset. The balance of the deferred inflow of resources should be adjusted to reflect the value of the remeasured asset at each reporting date. Changes in the fair value of the asset and adjustments to the related deferred inflow of resources should be recognized in resource flows statements as revenue and reduction of revenue, as appropriate. 36. If a government is entitled to a lead interest, the distribution received from the third party should reduce the previously recognized asset. Revenue should be recognized and the related deferred inflow of resources should be reduced as the periodic payments are received. 37. If a government is entitled to a remainder interest, the asset should be reduced at the termination of the agreement for the amount received. Revenue should be recognized and the related deferred inflow of resources should be reduced in an amount equal to the distribution from the third party. Any remaining asset and related deferred inflow of resources recognized for the beneficial interest also should be eliminated. EFFECTIVE DATE AND TRANSITION 38. The requirements of this Statement are effective for periods beginning after December 15, 2016. Earlier application is encouraged. Accounting changes adopted to conform to the provisions of this Statement should be applied retroactively by restating financial statements, if practical, for all prior periods presented. If restatement for prior periods is not practical, the cumulative effect of applying this Statement should be reported as a restatement of beginning net position (or fund balance or fund net position, as appropriate) for the earliest period restated (generally the current period). In the first period that this Statement is applied, the notes to the financial statements should disclose the nature of the restatement and its effect. The provisions of this Statement need not be applied to immaterial items. 7

GLOSSARY 39. This paragraph contains definitions of certain terms as they are used in this Statement; the terms may have different meanings in other contexts. Beneficial interest The right to a portion of the benefits from donated resources pursuant to splitinterest agreements in which the donor enters into a trust or an equivalent arrangement and transfers the resources to an intermediary. Intermediary The trustee, fiscal agent, government, or any other legal or natural person that is holding and administering donated resources pursuant to a split-interest agreement. Irrevocable split-interest agreement A split-interest agreement in which the donor has not reserved, or conferred to another person, the right to terminate the agreement at will and have the donated assets returned to the donor or a third party. Lead interest The right (a type of beneficial interest) to all or a portion of the benefits of resources during the term of a split-interest agreement. Life-contingent term A term specifying that the termination of a split-interest agreement is contingent upon the occurrence of a specified event, commonly the death of either the donor or other lead interest beneficiary. Period-certain term A term specifying that the termination of a split-interest agreement occurs after a specified number of years. Remainder interest The right (a type of beneficial interest) to receive all or a portion of the resources remaining at the end of the split-interest agreement s term. Split-interest agreement Agreements in which the donor enters into a trust or an equivalent arrangement under which the donor transfers resources to an intermediary to administer for the unconditional benefit of at least two beneficiaries, one of which could be a government. Unconditional right A right belonging to the government that cannot be taken away without the government s consent, such as an unconditional beneficial interest. 8

Variance power The unilateral power to redirect the use of the transferred resources to another beneficiary, overriding the donor s instructions. This transfer would occur without the approval of the donor, specified beneficiaries, or any other interested party. 9

Appendix A BACKGROUND A1. Resources received pursuant to split-interest agreements have been previously subject to the guidance provided in Statement 33 and Question 7.72.10 of the Comprehensive Implementation Guide (2013 2014). Since the release of that guidance, stakeholders have requested that the Board develop specific guidance for split-interest agreements in which a third party is holding and administering the donated resources for the benefit of a government. Most recently, respondents to the June 2013 Preliminary Views, Fair Value Measurement and Application, requested that the Board consider providing specific guidance for split-interest agreements. A2. Although the limited guidance on this topic may not affect a broad range of state and local governments, it is significant to certain types of governments that receive private contributions, such as public colleges and universities, public hospitals, and other public healthcare providers. Consequently, the Board added this topic to its technical plan as a potential standards-setting topic and initially referred to it as irrevocable charitable trusts. A3. At the October 2013 Governmental Accounting Standards Advisory Council (GASAC) meeting, GASAC members commented favorably on several potential preagenda research activities for governments engaged in business-type activities. In December 2013, the Board initiated pre-agenda research activities related to this topic. Preagenda research showed that a significant number of colleges and universities engage in one or more types of split-interest agreements. Furthermore, the results of a survey of financial statement users indicated that information on split-interest agreements is important to the respondents, to the extent that resources in trusts held by the government or by a third party can be used to fund operations or debt service of the government. A4. In May 2014, the Board added a project on this topic to the practice issue portion of the GASB s current technical agenda. Deliberations began in July 2014. During these deliberations, the Board also received feedback from GASAC members and subject matter experts. 10

Appendix B BASIS FOR CONCLUSIONS Introduction B1. This appendix discusses factors considered significant by Board members in reaching the conclusions in this Statement. It includes discussion of the alternatives considered and the Board s reasons for accepting some and rejecting others. Individual Board members may have given greater weight to some factors than to others. Scope and Applicability B2. In establishing the scope of this Statement, the Board concluded that only guidance for nonexchange transactions defined as irrevocable split-interest agreements should be addressed. As a result, the scope of this Statement excludes accounting and financial reporting for endowments and pledges. B3. The Board also considered revocable agreements in which a donor has reserved, or conferred to another person, the right to terminate the agreement at will and have the donated assets returned to the donor or a third party. Furthermore, the Board considered governmental benefits that are conditional upon an action or the occurrence of an event. The Board concluded that sufficient guidance for revocable agreements and conditional benefits already exists in Statement No. 33, Accounting and Financial Reporting for Nonexchange Transactions and, therefore, limited the scope of this Statement to irrevocable split-interest agreements that confer an unconditional right. B4. Another issue considered in the development of the scope of this Statement was the wide variability of provisions that can be articulated in an irrevocable split-interest agreement. Some agreements require that the beneficiary government also be the intermediary. In other cases, agreements stipulate that a third party other than the government should hold and administer the donated resources for the benefit of the government. The scope of this Statement was defined to include guidance for irrevocable split-interest agreements in general, while differentiating between the cases in which the government is the intermediary and the cases in which a third party is the intermediary. B5. Another factor considered in the development of the scope of this Statement was the instrument utilized to create the agreement. Generally, irrevocable split-interest agreements are created through trusts. However, split-interest agreements can be created without a trust, such as life-interests in real estate and charitable annuity gifts. The Board concluded that the instrument used to create irrevocable split-interest agreements should not be considered a distinguishing factor in defining the scope of this Statement. B6. The Board also considered arrangements in which a donor establishes a trust, in perpetuity, for the sole or shared benefit of a government. Although beneficial interests in 11

perpetual trusts have characteristics similar to beneficial interests in split-interest agreements, the Board believes that a determination of whether these resources should be recognized as liabilities, deferred inflows of resources, or revenues should be made in the broader context of voluntary nonexchange transactions, such as endowments, a topic explicitly excluded from the scope of this Statement. Thus, the Board concluded that it would not be appropriate to provide guidance for beneficial interests in perpetual trusts in this Statement. A Government Is the Intermediary Assets B7. Resources received by a government pursuant to a split-interest agreement in which the government is both a beneficiary and the intermediary meet the asset definition articulated in Concepts Statement No. 4, Elements of Financial Statements: assets are resources with present service capacity that the government presently controls. Furthermore, these assets usually meet the definition of an investment as articulated in paragraph 64 of Statement 72: an investment is a security or other asset that (a) a government holds primarily for the purpose of income or profit and (b) has a present service capacity based solely on its ability to generate cash or to be sold to generate cash. However, in some cases, donors transfer resources that do not meet the definition of an investment, such as certain real estate donations. The Board concluded that guidance for asset recognition in irrevocable split-interest agreements should not differ based on the type of assets received. Liabilities B8. Liabilities in irrevocable split-interest agreements arise when the government, acting as intermediary, accepts a present obligation to distribute specified amounts of the donated resources to other beneficiaries. Questions have been raised as to whether certain liabilities that arise in irrevocable split-interest agreements should be accounted for as derivative instruments for financial reporting purposes. In reviewing this topic, the Board concluded that Statement No. 53, Accounting and Financial Reporting for Derivative Instruments, should not be applied to irrevocable split-interest agreements because those standards were developed in the context of governmental exchange transactions. In reaching this conclusion, one issue the Board considered is the characteristic defined in Statement 53 as leverage. Leverage requires no initial net investment or an initial net investment that is smaller than would be required for other types of contracts that would be expected to have a similar response to changes in market factors (paragraph 7b). Because split-interest agreements can be considered part exchange and part nonexchange transactions, it is difficult to determine the existence of leverage in the governmental environment. The Board also considered the Statement 53 requirement to bifurcate hybrid financial instruments when the economic characteristics and risks of the derivative instrument are not closely related to the economic characteristics and risks of the companion instrument (paragraph 64c). The Board considered the operational challenges of bifurcation and concluded that all 12

obligations assumed pursuant to split-interest agreements should be accounted for as liabilities (and not as hybrid financial instruments). Deferred Inflow of Resources B9. The Board considered the current definitions of financial statement elements to evaluate whether beneficial interests in resources recognized as assets, in the scope of this project, should be recognized as revenues or deferred inflows of resources. Question 7.72.11 of the Comprehensive Implementation Guide as of June 30, 2013, directed governments to recognize as gift revenue the difference between the asset and the liability to other beneficiaries. However, the introduction by Concepts Statement 4 of deferred inflow of resources as an element of financial statements and the concept of applicability to a reporting period led the Board to conclude that resources recognized as assets pursuant to irrevocable split-interest agreements meet the definition of a deferred inflow of resources at inception of the agreement. The Board believes that revenue should be recognized under irrevocable split-interest agreements when resources become applicable to the reporting period. Measurement B10. This Statement provides guidance for two specific situations: (a) when the government is the lead interest beneficiary and (b) when the government is the remainder interest beneficiary. However, the measurement for the lead interest benefit is the same, whether recognized as a liability or a deferred inflow of resources. Likewise, the measurement of the remainder interest benefit is the same whether recognized as a liability or a deferred inflow of resources. The measurement of the lead interest benefit is based on the provisions of the irrevocable split-interest agreement that specify the frequency and amount of the periodic disbursements, while the measurement of the remainder interest is the difference between the related assets and lead interest benefit, as described below. Lead Interest Benefit B11. The measurement of the lead interest benefit can vary depending on the terms of the irrevocable split-interest agreement. For example, the disbursement amount can be defined as a specific percentage of the fair value of the assets at the time of the donation (an annuity) or as a specific percentage of the fair value remeasured every year (unitrust format). Furthermore, the unitrust format can limit the amount of the disbursement up to the income earned by the trust assets during a specific period or create make-up provisions. In addition, the donor can determine that the agreement would end after a specified number of years or would be contingent upon the lives of beneficiaries (life-contingent). Based on the variability of split-interest provisions observed, the Board concluded that governments can apply an established valuation technique for the measurement of the lead interest benefit that can adequately take into account the provisions of each specific agreement. The Board also concluded that it would be appropriate to identify in the Statement some of the possible assumptions that a government would consider when measuring the lead interest benefit without providing specific guidance on the approach to incorporate the assumptions. 13

B12. The Board concluded that the appropriate measurement attribute for the lead interest benefit is settlement amount. Paragraph 42 of Concepts Statement No. 6, Measurement of Elements of Financial Statements, describes settlement amount as the amount at which an asset could be realized or a liability could be liquidated with the counterparty, other than in an active market. Concepts Statement 6 further states that settlement amount represents the amount that will be realized from an asset or needed to liquidate a liability in due course according to the terms of an arrangement between a government and a counterparty. A settlement amount may be a discounted or an undiscounted amount. Because the lead interest benefit is not measured at fair value, the Board concluded that the lead interest benefit should be reported at settlement amount regardless of whether the lead interest benefit is recognized as a liability or a deferred in flow of resources. The Board believes that the only periodic adjustments that should be considered are significant mortality risk changes. Remainder Interest Benefit B13. The Board concluded that the remainder interest benefit should be measured as the value of the donated assets pursuant to a split-interest agreement, minus the related lead interest benefit. This measurement approach reflects the risk exposure applicable to the remainder interest. The Board concluded that the remainder interest benefit should be remeasured to reflect the new remaining amount at each financial reporting date. The Board believes that remeasurement of the remainder benefit would allow financial statement users to better assess the net position of a government benefiting from an irrevocable split-interest agreement. Life-Interests in Real Estate B14. In donations of life-interests in real estate, a donor transfers title of its property to a government and retains the right to use the property for the remainder of the donor s life. Examples of real estate donated include residences, farms, and vacation homes. The Board believes that, at the inception of the transaction, the government has control over the donor s property because the donor transfers the deed and title to the property to the government. Therefore, the Board concluded that the government should recognize the donated asset as a capital asset or an investment, depending on the facts and circumstances at the time of the donation. The Board believes that the government should determine, at the time of the donation, whether the donated property will be used as a capital asset or an investment when the donor s retained right to use expires. Donor-imposed restrictions on the use of the donated property may affect that determination. For example, a donor may require that a farm donated pursuant to a life-interest in real estate can be used by the university only to carry on agricultural research after the donor s retained right to use expires (a capital asset). In other circumstances, a donor may choose not to impose restrictions on use and the government benefiting from the life-interests in real estate donation decides, at the inception of the agreement, to sell the donated residence when the donor s retained right to use expires (an investment). 14

B15. The Board concluded that the donor s retained right to use does not meet the definition of a liability as provided in Concepts Statement 4. Even though the government has an obligation to provide the donor with access to the donated residence, the government s obligation to allow access does not vary throughout the term of the agreement. Furthermore, the Board considered the issue of the right to use during the deliberations leading to Statement No. 60, Accounting and Financial Reporting for Service Concession Arrangements. Paragraph 51 of the Basis for Conclusions describes the consideration of the right to use: while a transferor has an obligation to provide an operator with access to the facility, the value of the transferor s obligation to allow access does not vary according to the amount of consideration received. Consistent with previous decisions, the Board concluded that the most appropriate element to recognize for the donor s retained right to use is a deferred inflow of resources. B16. The Board determined that a deferred inflow of resources recognized for the right to use can be measured by considering the payments that a tenant would make for this specific or similar property pursuant to a lease agreement. The valuation technique required is the present value of the estimated rental payments, taking into account the actuarial life expectancy of the donor or any other established beneficiaries. However, the deferred inflow of resources related to this transaction is not subject to remeasurement because the fair value measurement attribute is not required. B17. In certain situations, a government may accept a life-interest in real estate agreement and assume certain contractual obligations with regard to the donated property. For example, a government may agree to pay for insurance premiums, maintenance, or repair of the donated property during the donor s tenancy. The Board concluded that those contractual obligations meet the definition of a liability provided in paragraph 17 of Concepts Statement 4: liabilities are present obligations to sacrifice resources that the government has little or no discretion to avoid. A Third Party Is the Intermediary B18. An issue for which there was no previous specific authoritative guidance was whether beneficial interests in resources contributed pursuant to split-interest agreements that are held and administered by a third party, for the benefit of the government, as defined in this project, meets the definition of an asset. The two main characteristics of an asset are control and present service capacity. Concepts Statement 4 expands on both characteristics. Paragraph 12 states that control of an asset is the ability of the government to utilize the resource s present service capacity and to determine the nature and manner of use of the present service capacity embodied in the resource. Paragraph 9 states that the present service capacity of a resource that is an asset is its existing capability to enable the government to provide services, which in turn enables the government to fulfill its mission. Asset Recognition B19. The question of whether assets should be recognized when a donor contributes resources to a third party for the benefit of a government is complex. The government does 15

not have custody (is not holding or administering) of the resources. Therefore, to recognize the beneficial interests as assets, the government specified as beneficiary of the agreement will need to demonstrate both control over the resources and that the resources provide present service capacity to the government. Control B20. The Board believes that in order for a government to establish control over the beneficial interests, the government should first determine that the donated assets have been placed beyond the control of the donor and that those beneficial interests are not subject to modifications. Paragraph 13 of Concepts Statement 4 states that control of the present service capacity embodied in an asset generally arises from contractual rights or legal ownership. The Board believes that the government as a beneficiary of resources held by third parties, pursuant to an irrevocable split-interest agreement, has an enforceable right over those resources. The Board believes that beneficial interests should meet the criteria in items (a) (e) in paragraph 34 of this Statement to demonstrate control over the resources. Present Service Capacity B21. After a government determines that it has control over its beneficial interests held by a third party, the government should assess whether the interests can be assigned, transferred, or pledged in exchange for consideration (present service capacity). Concepts Statement 4, paragraph 12, states, generally, the government controlling the asset has the ability to determine whether to (a) directly use the present service capacity to provide services to citizens; (b) exchange the present service capacity for another asset, such as cash; or (c) employ the asset in any of the other ways it may provide benefit. The Board believes that a government can assert control only over the present service capacity of beneficial interests held by a third party establishing its ability to exchange the beneficial interests for consideration (cash) item (b). B22. Pursuant to an irrevocable split-interest agreement, the donor confers legal title to the property to the intermediary, and equitable title to the beneficiaries. The Board believes that an equitable title can be exchanged. Therefore, the Board concluded that a government that can transfer these interests in exchange for consideration could assert that the resources provide present service capacity. Accordingly, the Board concluded that meeting the criteria in items (f) and (g) of paragraph 34 of this Statement is needed to demonstrate the government s control over the present service capacity of the beneficial interests. B23. However, it should be noted that monetization of the rights to the future cash flows could be impracticable from the perspective of the government. Therefore, the Board s discussion focused on the government s right to assign beneficial interests in exchange for consideration, rather than the likelihood of the government actually exercising that right. The donor s intent, when creating these beneficial interests, is to provide resources to the government in a specific future period. Thus, it can be argued that assigning beneficial interests in exchange for immediate consideration may be inconsistent with the donor s 16