Previous post described how the accounting literature defines a bargain purchase.
This post will give an example.
Let’s say a friend of your organization is a real estate investor who has a small building available and would like to provide it to the organization. The building is not in the nice, high-rent downtown area but is still in a very average area of one of the outlying suburbs. The benefactor can’t afford to make this space available for free, because there are property taxes and other costs involved. So the benefactor offers the space to the organization at a price of $10,000 per year.
The property would nicely meet the needs of the organization, so you snap up the offer and move in. What are the accounting entries?
Well, that depends on what the office space is worth.
The benefactor says it is worth $60,000 per year. You, the CFO, ask how he came up with that amount.
Your benefactor owns an identical building right next door. He is leasing that building out for $60,000 a year for the same term as he provided you and he signed a lease two months before you moved in.
Since he is an active investor, he also gave you the per square-foot rate of his property and the asking price for five other properties of similar size, similar quality, and similar accessibility within a one mile radius. Because he is in the market, he knows that office space is currently going for about the asking rate, which means there are no major discounts now.
That sounds like a really solid measure of what the leased space is worth. You record a contribution.
After 12 months, the total of your journal entries would look like this:
- Lease expense $60,000 (debit)
- Cash $10,000 (credit)
- Contribution $50,000 (credit)
Your auditor agrees with recognizing that contribution on the basis of an inherent contribution, or bargain purchase. Being a good auditor, she asks you for something to support the valuation. You talk to your benefactor and in return for a promise of confidentiality, he sends you an e-mail containing all of the information he provided you earlier.
Notice the contribution is the difference between the fair value of what was received and the resources provided. Also notice that the fair value is based on very comparable properties. The comparisons are from the immediate area, not the high-rent downtown district. Comps are for similar size and quality properties.
Also, there is something to back up the estimate.
Since I made up the whole example, I made up extremely solid support. Real situations aren’t usually that clear.
Most organizations probably have several bargain purchases every year.
Here are two examples.
Let’s say your printer is a friend of the ministry and gave you a deal on materials for your annual banquet. He said he would otherwise charge $1,500 but will only charge you $500. You are familiar enough with what other printers charge to know that the $1,500 amount is in the range of the going rate for your community.
There is a $1,000 inherent contribution.
Let’s say you have a remodeling job and received a several qualified bids in the $20,000 to $25,000 range. A contractor who’s been a small supporter for many years hears about the project and offers to do it for $5,000 because that’s a way he can finally help the organization in a really big way. He’s capable, licensed, does quality work, and is available, so you give him the contract. There is a $15,000 inherent contribution. You could argue, if you want to do so, that there is a $20,000 inherent contribution.
Typically those amounts for most NPOs would be quite immaterial to the financial statements and there wouldn’t be any contribution recorded.
When the amounts get to be some bigger numbers then usually they would be booked. You will need to decide when to start recording those, perhaps in consultation with your auditor.
Again, there are two main points. First, fair value is used to evaluate what was received. Second, the contribution is the difference between what was received and what was provided.
I hope these two posts help nonaccountants understand the concept of bargain purchase.