What is a bargain purchase? Part 1

I think it’s about time to talk about bargain purchases and review what the accounting literature has to say.

That’ll be exciting,” I hear you say.

I know, I know.  This is cool stuff.

Bottom line

The core issue is fair value: what is the fair value of the goods or services received? The second point is the contribution component is the difference between fair value and the amount paid for the goods or services.

Accounting literature

The bargain purchase concept shows up in a couple of places. The technical term is inherent contribution.  The Accounting Standards Codification is now the place where the rules are accumulated to define what makes up generally accepted accounting principles. Here’s a definition from the Accounting Standards Codification:

Glossary:

Inherent Contribution

A contribution that results if an entity voluntarily transfers assets (or net assets) or performs services for another entity in exchange for either no assets or for assets of substantially lower value and unstated rights or privileges of a commensurate value are not involved.

The Accounting Standards Codification has the following comment, which by the way, is authoritative:

720-25-15-2 The guidance in this Subtopic applies to contributions of cash and other assets, including promises to give. For contributions received, see paragraph 605-10-15-3.

720-25-15-3 The guidance in this Subtopic does not apply to the following transactions and activities:

a. Transfers of assets that are in substance purchases of goods or services—exchange transactions in which each party receives and sacrifices commensurate value. However, if a donor entity voluntarily transfers assets to another or performs services for another in exchange for assets of substantially lower value and no unstated rights or privileges are involved, the contribution inherent in that transaction is within the scope of this Subtopic.

From the perspective of a recipient, that means there is a contribution if the amount of goods or services received is greater than the assets provided in exchange. This would look like a purchase, except there is a disparity between the value of what was given and what was received. The difference is a contribution.

The inherent contribution concept goes back to SFAS #116, which said:

3. This Statement applies to contributions of cash and other assets, including promises to give. It does not apply to transfers of assets that are in substance purchases of goods or services—exchange transactions in which each party receives and sacrifices commensurate value. However, if an entity voluntarily transfers assets to another or performs services for another in exchange for assets of substantially lower value and no unstated rights or privileges are involved, the contribution inherent in that transaction is within the scope of this Statement.

SFAS #116 is no longer authoritative. The text of the document has been rolled into the Accounting Standards Codification.

The exposure draft of the NPO audit guide has a comment that describes what has been the routine practice. Remember this is a draft and therefore nonauthoritative.

5.42 Transactions that are in part a contribution and in part an exchange transaction (also referred to as bargain purchases) include an inherent contribution. The FASB ASC glossary defines an inherent contribution as a contribution that results if an entity voluntarily transfers assets (or net assets) or performs services for another entity in exchange for either no assets, or for assets of substantially lower value, and unstated rights or privileges of a commensurate value are not involved. For example, an individual has a home currently valued at $150,000, which is subject to a mortgage of $30,000. If the individual pays off the mortgage and sells the home to an NFP for $50,000, a contribution of $100,000 is inherent in the transaction. The Financial Reporting Executive Committee (FinREC) believes that in circumstances in which the transaction is in part a contribution and in part an exchange, NFPs should first determine the fair value of the exchange portion of the transaction, with the residual (excess of the resources received over the fair value of the exchange portion of the transaction) reported as contributions.

Notice what is now made explicit: determine the fair value first and then calculate the GIK revenue as the difference between fair value and the amount paid.  That concept is obviously present in the comment in SFAS #116 and current ASC, but is made explicit in the draft audit guide.

To make the example in the draft audit guide clear, here would be the journal entry for the NPO acquiring the property:

  • Real estate       150,000 (debit)
  •             Cash                  50,000 (credit)
  •             Contribution    100,000 (credit)

Question for the CPAs reading this – are there some more references I should include?

Next post – an example

One Response to What is a bargain purchase? Part 1

  1. […] Previous post described how the accounting literature defines a bargain purchase. […]

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