Split-interest agreements are charitable giving arrangements in which NFPs receive benefits that are shared with other (usually noncharitable) beneficiaries. NP 8.6.2.2 addresses split-interest agreements when the assets are held by a third party and thus subject to the three-party framework. A split-interest agreement is defined in the ASC Master Glossary.
ASC Master Glossary
The accounting requirements for the recognition, measurement, and presentation of split-interest agreements are provided in ASC 958-30, Split interest agreements. ASC 958-30-55-30 provides an illustration of journal entries for accounting for the following types of split-interest agreements:
In a typical split-interest agreement, a donor makes a gift by transferring assets to either a third-party (for example, an intermediary NFP or bank trust department) or directly to the NFP (depending on the type of agreement). The donated assets are invested and administered for the term of the arrangement (e.g., a fixed period, the lifespan of a specified individual, or in perpetuity) and periodic distributions are made in accordance with the donor’s request.
The time period covered by the agreement typically is expressed either as a specific number of years or as the remaining life of an individual or individuals designated by the donor. Based on the donor’s instructions in the trust instrument, the NFP may ultimately have unrestricted use of the resources to which it is ultimately entitled from the trust, or the donor may place time or purpose restrictions on their use.
Arrangements structured as charitable gift annuities (NP 8.7.3) and pooled (life) income funds (NP 8.7.4) are administered directly by the NFP charitable beneficiaries. Charitable lead and remainder trusts can be administered by either the NFP beneficiary or an independent third-party.
In charitable lead or charitable remainder trust arrangements, the NFP beneficiary will have either the right to distributions during the agreement’s term (the lead interest) or the right to the assets remaining at the end of the agreement’s term (a remainder interest). Ultimately, all the contributed assets together with the associated investment return will be “split” among the beneficiaries, after which the trust terminates. The accounting requirements depend primarily on the nature of the NFP’s interest (lead or remainder) and on whether the NFP or an independent third party serves as trustee.
If the split-interest assets are held by a third party, the arrangement is considered a three-party contribution transaction, the general accounting considerations for which are discussed at NP 8.6.2. If the NFP will hold the assets and administer the trust, see NP 8.7.2.
Generally, an NFP recognizes contribution revenue and the related assets and liabilities when an irrevocable split-interest agreement naming it trustee or fiscal agent is executed.
When split-interest trusts are irrevocable and the donor has not retained the right to substitute another charitable beneficiary, the NFP has an unconditional right to the benefits represented by the charitable portion of the trust, which will be reported as contribution revenue by the NFP.
The portion representing contribution revenue for the NFP depends on whether the NFP holds the lead interest (the right to distributions during the agreement’s term) or the remainder interest (the right to the assets remaining at the end of the agreement’s term).
When the NFP holds the assets and administers the trust, its balance sheet reflects the trust assets along with the trust’s liability for the obligation to make future payments to the other beneficiary (or beneficiaries) (see NP 8.6.2.2 for circumstances where the NFP does not hold the assets). The obligation to make payments is limited by the amount of assets in the trust. If the assets in the trust are exhausted, the trust terminates, and the NFP has no further responsibility. Thus, the liability is considered a liability of the trust, not a general obligation of the NFP.
At initial recognition, the difference between the fair value of the assets received and the fair value of the liability to the other beneficiaries is recognized as donor-restricted contribution revenue. That liability might relate to the lead interest (if the other beneficiary has the right to periodic payments from the trust assets during the term of the agreement), or it might pertain to a single payment representing the remainder interest (if the other beneficiary has the right to the assets remaining at the end of the agreement’s term).
Appendix A of chapter 6 of AAG-NFP contains excerpts from an AICPA white paper, Measurement of Fair Value for Certain Transactions of Not-for-Profit Entities, that are relevant to measurement of split-interest agreements. Paragraphs 67 through 102 of that white paper address the application of ASC 820-10-35 in determining the fair value of contribution revenue and the obligation to other beneficiaries under split-interest agreements. If present value techniques are used to measure fair value, the liability is generally measured at the present value of the future payments to be made to the other beneficiaries. Any present value technique for measuring the fair value of the contribution or payments to be made to other beneficiaries must consider the estimated return on the invested assets during the expected term of the agreement, the contractual payment obligations under the agreement, and a discount rate commensurate with the risks involved.
The contribution portion of the agreement may be subject to explicit donor-imposed restrictions relating to time or purpose. In addition, the contribution is usually subject to an implied time restriction.
The obligations for certain split-interest arrangements will contain embedded derivatives. Identifying those situations and the accounting applied in them is discussed at NP 8.7.2.3.
At each reporting date, trust assets are remeasured based on the guidance discussed in NP 9 for investment accounting.
Distributions to the lead beneficiary (either the NFP itself in a lead trust or to the other beneficiary, if a remainder trust) are made in accordance with the terms indicated by the donor (for example, based on a fixed annuity amount or a percentage of the fair value of the trust assets). If the NFP holds the lead interest, it reflects the periodic reduction of trust assets associated with the distributions along with corresponding increases in assets that belong to the NFP. Reclassifications from net assets with donor restrictions to net assets without donor restrictions are made in connection with each distribution (assuming the donor imposed no other time or purpose restrictions). If the non-charitable beneficiary holds the lead interest, the distribution from trust assets also will reduce the liability to the other beneficiary.
The NFP does not reflect the trust’s investment return in its statement of activities because it possesses an undivided interest (i.e., non-exclusive claim) in the assets, which is shared among all beneficiaries. Thus, investment return (including the change in fair value of the trust assets) is reported as an increase or decrease in the obligation to other beneficiaries. The liability to the other beneficiary(ies) is remeasured at the same time as the assets, resulting in a net adjustment.
In accordance with ASC 958-30-35-6, the NFP has two choices for remeasuring the liability. It can elect the fair value option pursuant to ASC 825-10-25 (and thus, remeasure the obligation at fair value). If that is done, the NFP would use the same fair value measurement technique that was used at inception. If fair value is based on the present value of payments to be made, the NFP updates all the assumptions, including the discount rate, to reflect current market conditions. Alternatively, the NFP can amortize the discount associated with the obligation (in a remainder trust) or contribution (in a lead trust) and adjust for changes in life expectancies (if payments are life dependent); in this case, the discount rate is not revised after initial recognition. The changes resulting from remeasuring the liability are reflected in the statement of activities as change in value of split-interest agreements, which increases or decreases donor-restricted net assets.
According to AAG NPO 6.35, the preferred approach is to remeasure the liability at fair value.When the lead interest terminates (typically upon the death of the non-charitable beneficiary), the assets in the trust are distributed to the remainder interest beneficiary, the asset and liability accounts are closed (i.e., the trust terminates), and any difference between those balances is recognized as a change in the value of split-interest agreements in the net assets with donor restrictions class. If the NFP holds the remainder interest, a reclassification from net assets with donor restrictions to net assets without donor restrictions would be made upon the distribution from the trust, if no other donor-imposed time or purpose restrictions on use of the assets exists.
As discussed in NP 8.7.2.2, when an NFP charitable beneficiary also serves as trustee for a lead or remainder split-interest agreement, the NFP’s balance sheet reflects trust assets along with a liability for the obligation to make future payments to the other beneficiary (or beneficiaries). That liability might relate to the lead interest (if the other beneficiary has the right to periodic payments from the trust assets during the term of the agreement), or it might be a single payment representing the remainder interest (if the other beneficiary has the right to the assets remaining at the end of the agreement’s term).
If the amount of the NFP’s obligation is directly affected by changes in the value of the assets in the trust (as explained in NP 8.7.2.4), the liability contains an embedded derivative that may need to be accounted for separately. In those circumstances, the obligation would be considered a hybrid instrument under ASC 815-15, Embedded derivatives, consisting of a “debt host contract” and the embedded derivative, as described in ASC 958-30-35-7. The embedded derivative must be measured at fair value as required by ASC 815-10-30-1 (for initial measurement) and ASC 815-10-35-1 (for subsequent measurement). In order to accomplish that, it may be necessary to separate the embedded derivative from the host contract.
Excerpt from ASC 958-30-35-7
The debt host contract is the liability for the payment to the beneficiary that would be required if the fair value of the trust assets does not change over the specified period. The embedded derivative represents the liability (or contra-liability) for the increase (or decrease) in the payments to the beneficiary due to changes in the fair value of the trust assets over the specified period.
If the NFP’s obligation is to make a single payment to the other beneficiary for the assets remaining at the end of the agreement’s term (as in a CLAT or CLUT), the liability amount will always be affected by the performance of the investments over the trust’s term. Because the obligation is directly affected by changes in the value of the assets in the trust, all remainder interest obligations contain an embedded derivative.
On the other hand, if the NFP’s obligation is to make periodic payments to the lead beneficiary during the term of the agreement, the payment amounts will either be fixed (as in a CRAT) or variable (as in a CRUT). When the lead beneficiary is entitled to a fixed annuity payment throughout the agreement’s term, the amount of the NFP’s liability is unaffected by changes in the value of the trust assets. Therefore, no embedded derivative is present in a CRAT. However, if the payment amounts are based on a percentage of the fair value of the trust assets on a given date (and thus, can vary from period to period), the amount of the NFP’s liability is directly affected by changes in the value of the trust assets. In a CLUT, therefore, the NFP’s obligation will contain an embedded derivative.
Embedded derivatives must be bifurcated from the debt host liability and accounted for separately unless either:
If an arrangement containing an embedded derivative does not qualify for the life-contingent exception, most NFPs will elect to report the entire amount of the obligation to the other beneficiary at fair value, rather than separately accounting for the host contact and the embedded derivative. The NFP could make the election pursuant to a fair value option for hybrid instruments described in ASC 815-15-25-4, or based on the general fair value option for financial instruments described in ASC 825-10.
ASC 958-30-55-6 through ASC 958-30-55-20 provide eight examples (identified as Cases A through H) illustrating and explaining the analyses for potential embedded derivatives under various split-interest agreement structures. The conclusions for each type of arrangement are summarized in Figure NP 8-4.