The GAAP requirement for the reporting of gifts in-kind has been in existence for a number of years. In June 2018, the Board issued Accounting Standards Update No. 2018-08, Not-for-Profit Entities (Topic 958): Clarifying the Scope and the Accounting Guidance for Contributions Received and Contributions Made. This Standard focused predominately on the revenue recognition of donations in-kind and with a heightened focus on donated services rather than all nonfinancial assets. The presentation and disclosure of contributed nonfinancial assets differed greatly among nonprofit entities.

To help supplement its cash resources, many nonprofit entities rely heavily on donors for contributions, which can be classified as either financial or in-kind, i.e., nonfinancial assets. Financial contributions are commonly received in the form of grants, pledges, or donations and are received by the organization through a transfer of monetary funds from the donor. In-kind contributions are nonfinancial assets, including goods or services received at no cost or below market cost. Nonfinancial assets include tangible items such as food, clothing, medical or other supplies, furniture and intangible items such as services, voluntary labor, or facilities.

Some of the most frequently overlooked gifts in kind include contributions of advertising time, technical services, use of facilities, costs associated with fundraising events, collection items, car donations, and borrowings at below market interest rates.

In-kind services are only recorded on the organization’s financial statements if they meet specified criteria as determined by Generally Accepted Accounting Principles (GAAP), which requires services contributed in-kind must be performed by professionals and tradesmen with a specialized skill in the service. In-kind contributors are typically accountants, architects, carpenters, doctors, electricians, awyers, nurses, plumbers, teachers, and other professionals and tradesmen. When analyzing these types of services, the organization needs to focus on the notion of “specialized skills” GAAP also requires that contributed services create or enhance a nonfinancial asset belonging to the organization and that it would otherwise have to purchase the service. For example, an electrician donating his services during a construction project at a cost below market or for no cost. Under GAAP, the service would qualify as an in-kind contribution as the electrician has a specialized skill that the nonprofit would otherwise have to purchase. The organization would record the receipt of these services in the “statement of activities” with an offsetting expense or capital assets addition, as explained below.

There is a common misconception among nonprofits that because in-kind donations are provided at little or no cost, the organization doesn’t have to report them on its financial statements. Stakeholders and other readers of the financial statements might dispute that recording these items will merely gross-up revenue and expenses with no effect on the operating results. But conversely, 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, nonprofits are required to report these contributions.

GAAP requires the organization to report the donated items or services meeting the criteria for in-kind donations as revenue in the operating section of the organization’s “statement of activities” on the date the contribution is made known to the organization, regardless of the date on which the item or service is received. As explained in FASB ASC 958-605, the donated nonfinancial assets must be reported at fair market value, defined by ASC topic 820 as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.” As well, GAAP requires an offsetting expense in the proper natural expense category on the organization’s “statement of functional expenses,” also reported at the determined fair market value as described in ASC topic 820. Suppose the item or service is an asset that exceeds the organization’s capitalization policy, like the electrician cited above. In that case, the asset is recorded in the proper fixed asset category on the “statement of financial position,” and revenue is recognized for the asset’s fair market value. Determining the fair value to be recorded is often the most challenging part of the accounting exercise.

FASB Accounting Update

Based on stakeholder feedback, the FASB issued this update to increase transparency through enhanced financial statement presentation and disclosure of nonfinancial assets. However, the revenue recognition and measurement requirements for these nonfinancial assets remain unchanged in ASC 958-605.

FASB Accounting Standards Update (ASU) No. 2020-07, Presentation and Disclosures by Not-for-Profit Entities for Contributed Nonfinancial Assets, are effective for nonprofits with annual periods beginning after June 15, 2021, and interim periods within annual periods beginning after June 15, 2022. Early adoption of the standard is permitted by nonprofits. Retrospective transition is required. So any periods reported upon must comply with the updated standard. The enhanced presentation and disclosure requirements are:

• The contributed nonfinancial assets are stated separately from other contributions in the statement of activities.
• A footnote disclosure must be made to disaggregate the contributed nonfinancial assets by type such as food, medical supplies, fixed assets, facility usage, services, to name a few.
• The NFP’s policy (if any) on liquidating rather than using contributed nonfinancial assets for each type of nonfinancial asset identified.
• Qualitative considerations to be disclosed include:

  -Whether the contributed nonfinancial assets were liquidated.

  -A description of any restrictions requested at the time of contribution by the donors.

  -A description of the technique the organization uses to arrive at the fair value measurement of the nonfinancial asset in accordance with paragraph 820-10-50- 2(bbb)(1), at the time the asset is initially recorded.

  -The principal market used to arrive at the fair value measurement (The principal market is the market with the greatest volume of activity that the organization is legally able to access in order to value the asset.)

Under the new standard, when an organization receives donated services it must disclose the services received during the financial statement period, including the revenue recorded on the statement of activities and the programs or activities the services were used for. The organization is required under the new standard to provide disclosure regarding services received in-kind regardless of whether they meet the revenue recognition criteria defined by GAAP; however, the organization is only required to record revenue on the statement of activities if it meets the GAAP criteria. The standard allows for the nature and extent of such services disclosed but not recorded to be described in the footnotes by nonmonetary information, which can include but is not limited to the number of hours received in services or outputs provided by board members or volunteers, such as contributions raised. Many organizations may have donated services that are recorded as contributions and others that are only disclosed in the footnotes.

As the effective date of FASB Accounting Standards Update (ASU) No. 2020-07, Presentation and Disclosures by Not-for-Profit Entities for Contributed Nonfinancial Assets draws near, it will be important for nonprofit organizations to closely monitor the receipt of nonfinancial assets and services received as well as their methods of valuing such contributions. HBK Nonprofit Solutions team members will be happy to assist you with these accounting challenges.

Read the full Winter issue of Insights, the HBK Nonprofit Solutions quarterly newsletter.

The last in, first-out (LIFO) method of accounting for inventory is widely used by many manufacturing companies. The question is often posed, “Should we continue to use LIFO, or should we discontinue using LIFO?” Simply stated, it is time to quit using LIFO when there is no longer a benefit that outweighs the cost.

To determine whether there is a benefit, a business must first understand LIFO, which is an inventory valuation method that can result in tax savings for businesses in the United States that use Generally Accepted Accounting Principles (often referred to as “GAAP”). LIFO is not permitted under International Financial Reporting Standards. LIFO is used to closely match current costs against current revenues because of the assumption that recent purchases cost more than previously purchased items and will be sold first resulting in a higher cost of sales. The difference between the current inventory purchase price and previously purchased items are reported in a balance sheet reserve account.

If the inventory prices are subject to significant price fluctuations, the benefit of LIFO may diminish causing a decrease in the cost of sales and an increase in taxable income and, therefore, taxes. A few items that tend to have volatile prices are aluminum, lumber, steel, plastics, and oil. Businesses with inventory items that have significant price fluctuations that are not temporary will need to evaluate the continued benefit of using LIFO. For example, if newer inventory purchases cost less than older inventory or the commodity index for the item is declining, over time, this may result in a decrease in the inventory reserve and an increase in taxable income and taxes. This would indicate there is no longer a benefit if it is not a temporary price change. When there is no longer a tax benefit to using LIFO, the business will need to consider a change to another acceptable accounting method such as first-in, first-out (FIFO) or average cost. For financial statement purposes, the change would be retrospectively applied to prior financial statements.

While LIFO has benefits, an annual evaluation of price fluctuations is needed to determine the continued use of LIFO versus another acceptable method of accounting for inventory. In the existing economy, some of the aforementioned inventory items have seen significant price increases, however, it bears watching, since they do tend to fluctuate significantly. For assistance or questions regarding inventory valuation methods, please contact your HBK Advisor.

A common investment disclaimer reads, “Past performance is not a guarantee of future results.” The same applies to the world of construction. Annual and interim financial statements provide valuable information about a contractor’s past performance and current financial strength, but offer little clarity when it comes to what investors and lenders can expect going forward. That is why so many users of a contractor’s financial statements spend more time analyzing the company’s work-in-progress (WIP) schedule than they do their prior year’s income statement. There is a wealth of information buried in WIP reports that can be as beneficial to the contractor as those looking to invest in or provide financing for a project. This tool has proven itself critical to those who supply credit to a contractor (be it their surety or bank), so why do so many contractors fail to use it to run their businesses?

How WIP Works and What It Means

Under generally accepted accounting principles (U.S. GAAP), except in certain limited cases, contractors must recognize revenue on long-term contracts under the percentage-of-completion method. Under this method, revenue is recognized relative to progress toward completion of a job. For example, if a contractor has incurred 50 percent of their total costs on a project, they are able to recognize an equal percentage of the contract price on that job as revenue, regardless of how much they have billed or collected. The amount billed to date, over or under revenue recognized, is either a contract asset (underbillings) or contract liability (overbillings) and is reflected as such on the company balance sheet.

If a company has a large amount of underbillings, this can be a red flag for sureties and bankers, who may interpret them as potential future losses. It should also be a warning sign for the chief financial officer, controller and project managers before these figures are ever released to outside parties. Are these an indication of poor project management, delays in the billing process, or a need to update projected total costs on a job? Perhaps there are unapproved change orders for which work has begun or there are significant material costs that are not billable until installed. Each job can have its own unique situation that creates an underbilled scenario, so it is important to evaluate each job individually. Management should be prepared to explain underbillings and their cause while also being able to determine the proper response to correct any operational deficiencies that may have contributed to them.

Overbillings are generally viewed more favorably by creditors, as they are a way to have the customer finance the completion of the project. However, there are also some concerns to be aware of when it comes to overbillings. A WIP schedule with a combination of jobs with losses and jobs with large overbillings can indicate trouble ahead. In such a case, the billings from one project are essentially being used to cover the costs of other projects. This will create a squeeze on cash flow as the overbilled projects progress, the overbilling recedes, and cash received from one job is used to finance the completion of another. Think of it as a Ponzi scheme playing out in the financial statements. That is how creditors view it.

Overly Optimistic?

Lenders and surety bonding companies also focus on projected gross profit percentages for individual jobs. Are there any that look out of place given the contractor’s previous performance? Some contractors are eternal optimists and always project a best-case scenario when it comes to performance. If a contractor’s completed job schedule reports average profit margins of 20 percent, the lenders and sureties are certain to take a close look at jobs in progress that are projecting a gross profit of 25 percent or more. Contractors should ask themselves the same question and be able to explain why current jobs will outperform historical margins. Is there something different about this job that lends credence to the elevated gross profit percentage, or should we take a closer look at the cost to complete it? “Profit fade” is a term used to describe when gross profit from a contract is less than previously anticipated. Profit fade resulting from overly optimistic projections at an interim date will erode a creditor’s confidence in a contractor’s ability to estimate their job costs accurately. This in turn will result in reduced credit and lower bonding capacity for a contractor.

Monthly Job Reviews

A WIP schedule that is kept up on a monthly basis can be a great tool for measuring job performance. Of course, like any tool, it is only as good as the information that is put into it. If actual and estimated job costs are not correct, the report will be inaccurate and misleading, and the contractor will look incompetent in front of their surety and banker. Conversely, if monitored closely, warning signs, spotted early on, can help get a job back on track and avoid continued losses. The better a contractor becomes at monitoring their jobs in this fashion, the better they will be at preventing profit fade and demonstrating themselves as a skilled, knowledgeable and financially savvy player in the construction industry. Contact a member of HBK’s Construction Solutions Group for additional resources.

Original article published in The Dirt, Magazine.