Last month, we told you the AICPA

Transcription

1 The PPC Nonprofit Update, NOVEMBER 2010, Volume 17, No. 11 THE PPC NONPROFIT UPDATE More about the AICPA Nonprofit Financial Reporting Alert Last month, we told you the AICPA has updated its Financial Reporting Alert, Not-for-Profit Entities Accounting Issues and Risks 2010 (Financial Reporting Alert), and we summarized many of the economic, legislative, regulatory, and financial management issues discussed in the Financial Reporting Alert. This article highlights the additional content of the Financial Reporting Alert. Accounting Issues and Developments In the current economic environment, several accounting and financial reporting issues may affect nonprofit organizations. The following accounting pronouncements and related guidance are considered significant and are thus discussed in the Financial Reporting Alert: z Nonprofit organization mergers and acquisitions. z Accounting for uncertainty in income taxes. z Subsequent events. z Reporting costs paid by one nonprofit organization on behalf of another in circumstances in which the nonprofit organizations are affiliates. z Fair value. z Accounting for losses due to fraud. z Proposed guidance on credit quality and credit losses. z Convergence with International Financial Reporting Standards. z Private Company Financial Reporting. Audit and Attestation Issues The recent economic conditions and regulatory actions described in the Financial Reporting Alert may cause additional risk factors that did not previously exist or did not have a material effect on nonprofit organizations in prior years; therefore, auditors of nonprofit organizations will need to consider such factors in their audits of the financial statements. The auditor may need to increase the extent of audit procedures, perform procedures closer to year-end, or perform additional audit procedures to obtain additional or In this Issue: More about the AICPA Nonprofit Financial Reporting Alert Annual AICPA Risk Alert for Yellow Book and Single Audits Is Released SSARS 19 Is Effective at Year-End A Tale of Two Appraisals Same Taxpayer + Same Issue = Same Result Tax Brief This newsletter is also available online. Please call (800) , or order online at ppc.thomsonreuters.com.

2 2 The PPC Nonprofit Update, november 2010, Volume 17, No. 11 more persuasive audit evidence. The Financial Reporting Alert discusses the following topics on which auditors may be focusing their attention: z Fair value measurements. z Accounting estimates. z Organization s ability to continue as a going concern. On the Horizon. The Financial Reporting Alert presents information related to projects currently in process that may be of significance to nonprofit organizations or may result in significant changes. Resource Central The Financial Reporting Alert also contains information related to additional tools that may assist in an organization s financial reporting needs. Information includes publications, online libraries, continuing professional education, webcasts, hotlines, conferences, and AICPA member services. Additional Internet Resources Finally, the Financial Reporting Alert contains an appendix listing additional websites that may provide valuable information to nonprofit organization accountants. The Financial Reporting Alert is available on Checkpoint (currently under Advance Documents for AICPA Audit and Accounting Guides ) or may be ordered from the AICPA at (888) or Annual AICPA Risk Alert for Yellow Book and Single Audits Is Released AICPA audit risk alerts discuss nonauthoritative considerations for planning and performing audits. This year s audit risk alert for Yellow Book and single audits, Government Auditing Standards and Circular A-133 Developments 2010, covers several new issues and developments for you to consider if you perform audits in accordance with OMB Circular A-133. The risk alert is available at riag.com for readers who subscribe to the AICPA materials on Checkpoint. We discussed the AICPA s new audit guide for single audits, Government Auditing Standards and Circular A-133 Audits, in the October issue of this newsletter. Impact of SAS 117, Compliance Audits As you might expect, the effects of the new guidance for compliance audits provided by SAS 117 (AU 801), Compliance Audits, are pervasive in this year s edition of the audit risk alert. AU Section 801, which is effective for audits of fiscal periods ending on or after June 15, 2009, establishes standards for auditing compliance with a governmental audit requirement. The audit risk alert provides a summary of the new standard in the section devoted to audit and attestation issues and developments. The new guidance is also discussed when relevant in other sections of the risk alert, especially in areas where AU 801 provides guidance for adapting and applying auditing standards in a compliance audit. For example, the audit risk alert explains that the guidance provided in AU section 314 for understanding the entity and its environment in a financial audit should also be applied in the compliance portion of the audit by relating the guidance for assessing risks of material misstatement to risks of material noncompliance. Updated Recovery Act Guidance A significant amount of guidance relating to the American Recovery and Reinvestment Act of 2009 (Recovery Act) has been issued since the law was enacted in February The audit risk alert focuses attention on the Recovery Act by discussing: z An overview of single audit issues and recent developments, including guidance issued by the government for clarification and implementation of Recovery Act provisions z Auditee considerations for Recovery Act funds z Auditor considerations for Recovery Act funds z Oversight of Recovery Act funding On the Horizon As with audit risk alerts in previous years, the AICPA devotes a section to the description of auditing developments that are likely to affect auditors and the conduct of their audits in future years. The Government Accountability Office s project to revise Government Auditing Standards (the Yellow Book) is discussed, as is the Auditing Standard Board s clarity project. Auditors will need

3 The PPC Nonprofit Update, november 2010, Volume 17, No to monitor these projects to stay abreast of developments that could have a major impact on their audits. SSARS 19 Is Effective at Year-End SSARS 19, Compilation and Review Engagements, is effective for compilations and reviews of financial statements for periods ending on or after December 15, 2010 in other words, December 31, 2010 month-end or year-end financial statements. We ve gone over the main points of this far-reaching new Standard in previous articles. Now that it s time to implement, here are a few additional things you ll want to keep in mind. Pre-SSARS 19 Engagements Practitioners may still be performing pre-ssars 19 engagements after SSARS 19 becomes effective. For example, a practitioner could be wrapping up an October 31, 2010, quarterly review for one client and at the same time performing a December 31, 2010, month-end compilation for a different client. It will be important for the practitioner to make sure to use the correct accountant s report for each engagement during this transition period. Get Started on Your Reports After considering the effort it took us to update all the report examples in our various products, we feel your pain. If you have a large compilation and review practice, it is going to take some time to get all those reports updated to the new wording. (Don t forget to title those reports!) So, plan ahead and get started as soon as possible to update your word processing files. It will make getting those December 31, 2010, engagements out the door much easier. Conforming Changes SSARS 19 officially supersedes AR 20, AR 50, and AR 100. What happens to the rest of the AR sections? In their August 2010 meeting, the AICPA s Accounting and Review Services Committee (ARSC) reviewed conforming changes made to AR 110, AR 120, AR 200, AR 300, AR 400, and AR 600 required by the issuance of SSARS 19. The most notable conforming changes update the accountant s report language to conform to the reporting requirements in SSARS 19. However, the performance requirements are also updated. For example, practitioners compiling specified elements, accounts, or items of a financial statement under AR 110 will need to document their understanding with the client through a written communication with management. ARSC intends to make those conforming changes available in time for practitioners to have them when SSARS 19 becomes effective. PPC s Guide to Audits of Nonprofit Organizations (NPO) includes pre- and post-ssars 19 report examples. In the 2010 edition of PPC s Guide to Compilation and Review Engagements (CAR) we have updated all of the report examples to conform to SSARS 19. We have also included a limited number of pre-ssars 19 report examples. Subscribers to CAR on Checkpoint have access to most of the CAR 2009 report examples through a link in their Checkpoint content. Both NPO and CAR have Microsoft Word versions of all their reports included in the related PPC s Practice Aids. What About the Interpretations? Interpretations of SSARS are an interpretative publication according to AR That means if an accountant doesn t follow the guidance in an interpretation, the accountant should be able to explain how he was able to comply with the related SSARS. ARSC is looking at the various interpretations to the AR sections superseded by SSARS 19 (primarily interpretations to AR 100) to determine which interpretations, if any, are still applicable. ARSC will make conforming changes and withdraw interpretations as considered necessary. What s Next? ARSC has several smaller projects on its agenda. However, there is one larger project in the works. At its November 2010 meeting, ARSC will begin a Clarity Project. That project will (a) reformat the existing AR sections in a new format consistent with the clarified format being used for the auditing standards and (b) make some conforming changes for international standards. As part of the Clarity Project, ARSC will take the guidance that is currently in the interpretations of the SSARS and place that guidance in the appropriate part of the clarified standard. Also, the guidance in AR 200 on comparative financial statements will be separated into guidance on compilations (to be placed in AR 80) and reviews (to be placed in AR 90). However, the Clarity Project will take some time and the clarified SSARS aren t expected to be effective until We ll keep you up-to-date on the latest changes before they impact your practice.

4 4 The PPC Nonprofit Update, november 2010, Volume 17, No. 11 A Tale of Two Appraisals taxpayer must obtain a qualified appraisal to substantiate a noncash charitable contribution of more A than $5,000 [Reg A-13(c)(2)(i)(A)]. Strict requirements must be met in order for an appraisal to be a qualified appraisal. The ABCs The rules relate to the content and timing of the document, the appraiser s qualifications, and the permissible appraisal fee. Content/Timing. A donor must either employ an appraiser who is knowledgeable about the specific items that are included in a qualified appraisal or personally verify that the content satisfies IRS requirements. The appraisal must describe the property in sufficient detail so that a person who is not familiar with the property type can determine that what was appraised is what was (or will be) contributed. If it is tangible personal property, the appraiser must include its physical condition. Any restriction upon the donee s right to use, sell, or otherwise dispose of the property can reduce the value of the contribution. Therefore, the appraisal must provide the terms of any agreement or understanding entered into (or anticipated) between the donor and donee that limits the donee s use of the property. Finally, the appraisal must contain certain fundamental items: z Name, address, taxpayer identification number (TIN), and employment status (e.g., sole proprietor, partner, or employee) of the appraiser; name, address, and TIN of his employer, if applicable; and the qualifications of the appraiser; z date (or expected date) of the contribution; z a statement that the appraisal was prepared for income tax purposes; z the date (or dates) on which the appraisal was done; z the appraised fair market value (FMV); z the valuation method used to determine FMV (e.g., income approach, market data analysis, or replacement cost); and z the specific basis for the valuation (e.g., comparable sales). Only one qualified appraisal is required for a group of similar items contributed in the donor s same tax year. However, the donor has the option of obtaining separate qualified appraisals for each item. An appraisal must be made no more than 60 days before the date of contribution and must be received by the donor before the due date (including extensions) of the return in which the contribution deduction is claimed [Reg A-13(c)(3)(i)(A)]. Who s Qualified? The appraiser must be one that represents to the public that he or she is an appraiser or performs appraisals on a regular basis and a declaration to this effect must be included in the appraisal summary. The appraiser must be qualified to appraise the type of property being valued; e.g., an expert appraiser of rare books is not qualified to appraise real estate. Certain persons are automatically disqualified from being qualified appraisers (for example, the donor and donee of the property). It also includes anyone who was a party to the transaction (transaction party) in which the donor acquired the property (i.e., the person who sold, exchanged, or gave the property to the donor, or any person who acted as an agent for either party in the transfer). However, a party to the donor s acquisition of the property can be the appraiser when the property is donated within two months of acquisition by the donor and its appraised value does not exceed the acquisition price. Two additional categories of disqualified persons are (1) a person employed by the donor, donee, or transaction party (and certain persons related to that employee); and (2) an appraiser regularly used by the donor, donee, or transaction party if that appraiser does not perform a majority of appraisals during the tax year for other persons. Money Matters. Generally, no part of the appraiser s fee can be based on the appraised value of the donated property. A fee arrangement based on the amount of the appraised value allowed as a charitable deduction by the IRS is prohibited [Reg A-13(c)(6)(i)]. Note: There is an exemption to the value-based fee rule for fees paid to a generally recognized association that regulates appraisers, provided certain other requirements are met. Appraisers in the Courtroom A court is not bound by an expert appraiser s opinion and can choose to accept all, part, or none, of the appraisal, regardless of whether the appraiser is testify-

5 The PPC Nonprofit Update, november 2010, Volume 17, No ing for the taxpayer or the IRS [National Grocery Company, 304 U.S. 282 (1938)]. Courts evaluate an expert s opinion based in large measure on the expert s qualifications and credibility [Parker, 86 TC 547 (1986)]. When experts offer conflicting FMV opinions, a court normally weighs the merits of each opinion by examining the factors they considered in reaching their conclusions [Casey, 38 TC 357 (1962)]. A Comedy of Errors A recent case is a textbook example of a worthless appraisal [Evans, TC Memo (2010)]. The Evans granted two facade easements to a qualified conservation organization and claimed a $154,350 charitable contribution deduction. The appraiser who testified for the Evans prepared the appraisal almost four years after the contribution. Consequently, it failed one of the requirements for a qualified appraisal. (The Evans had two appraisals made within the required timeframe for a qualified appraisal, but did not have those appraisers testify.) But aside from the timeliness problem, the appraisal was critically flawed, and the appraiser was poorly prepared to testify. The appraiser acknowledged a variety of mistakes in the appraisal reports on cross-examination; e.g., incorrectly describing the restrictions imposed by the easements; making improper size adjustments for sales of several comparable properties; and making numerous math errors. To make matters worse, the appraiser had difficulty explaining the valuation methodology used to the court. Based upon the appraiser s testimony, the court suspected that the appraisal reports had been prepared without the appraiser personally inspecting the properties a Cardinal sin with respect to courtroom credibility. Finally, the appraiser claimed that the conditions for a qualified conservation contribution had been satisfied. However, the testimony revealed that the appraiser was not familiar with the requirements necessary for an appraisal to support the donation. In light of these shortcomings, the Court declined to give the appraisal reports any weight. A Failure to Communicate Another recent case [Lord, TC Memo (2010)], also involved a conservation easement donation. In this case, the appraiser s report failed to state the contribution date, the date the appraisal was performed, and the FMV of the easement contribution on the contribution date, all of which are required for a qualified appraisal under the regulations. The appraisal clearly was not a qualified appraisal. Undaunted, the taxpayer asserted that he substantially complied with the regulations by attaching a copy of the flawed appraisal to his income tax return and by including Form 8283 (Noncash Charitable Contributions). In rejecting Lord s claim of a charitable contribution, the court emphasized that the doctrine of substantial compliance is not applicable if significant information is omitted from an appraisal [Hewitt, 109 TC 258 (1997)]. Successfully defending a charitable contribution deduction for noncash property begins with an appraisal prepared by a qualified appraiser and a report that follows the format in the regulations. Ideally, the appraiser should have a successful track record with the IRS and in litigation. Same Taxpayer + Same Issue = Same Result Income consisting of interest, dividends, rents, and royalties is, of course, generally exempt from unrelated business income tax (UBIT). However, these income items are taxable if produced by debt-financed property, unless one of several exceptions applies. Generally, debt-financed property is any property [IRC Sec. 514(b) (1)]: (1) held to produce income; and (2) for which there was acquisition indebtedness at any time during the tax year (or, if the property was disposed of during the tax year, at any time during the 12 months before the disposition). Acquisition indebtedness, for any debt-financed property, is the unpaid balance of debt incurred by the organization [IRC Sec. 514(c)(1)]: z in acquiring or improving the property; z before acquiring or improving the property, if the debt would not have been incurred but for the acquisition or improvement; or z after acquiring or improving the property, if the debt would not have been incurred but for the acquisition or improvement, and the need to incur such debt was reasonably foreseeable when the property was acquired or improved. Failure to foresee a need does not necessarily mean it was not reasonably foreseeable [Reg (c)-1(a)].

6 6 The PPC Nonprofit Update, november 2010, Volume 17, No. 11 Margin Account Securities Investors often seek to leverage their investment dollars by borrowing funds collateralized by securities already owned in order to buy more securities. Are marginfinanced securities debt-financed property as defined in IRC Sec. 514(b)(1)? Another Bite at the Apple The Henry E. and Nancy Horton Bartels Trust for the Benefit of Cornell University (the Trust) has previously challenged, and lost, the IRS position that securities purchased on margin are debt-financed property that produces income subject to UBIT [Bartels, 85 AFTR 2d (2nd Cir. 2000), cert. den. 121 S. Ct. 426 (2000)]. After paying the taxes for the years involved in that litigation, the Trust filed amended Forms 990-T and claimed a refund. When the IRS denied the refund claim, the Trust sued in the Court of Federal Claims and lost on summary judgment [Bartels, 104 AFTR 2d (Ct. Fed. Cl. 2009)]. The Court of Appeals for the Federal Circuit has now upheld the decision of the Claims court [(Bartels, 106 AFTR 2d (Fed. Cir. 2010)]. In this latest litigation, the Trust argued that UBIT did not apply to its margin account income because (1) the UBIT requires showing unfair competition since Congress enacted the UBIT to prevent tax-exempt organizations from gaining an unfair competitive advantage over taxable entities; and (2) investing in securities is not a trade or business. The Court rejected the first argument by observing that its sole function is to enforce a statute according to its terms when the language is clear, and then concluding that Congress intended to impose the UBIT on all debtfinanced property, regardless of whether that particular type of property was a source of unfair competition. The Court also concluded that it does not matter whether investments in securities on margin satisfy the definition of related trade or business because IRC Secs. 512(b)(4) and 514 explicitly classify income from debt-financed property as income from an unrelated trade or business. Investment advisers are often unfamiliar with the UBIT rules applicable to their tax-exempt clients. Therefore, exempt organizations must communicate the UBIT implications of a margin account to their advisers. Tax Brief HEALTH INSURANCE TAX CREDIT. In the June 2010 issue of The PPC Nonprofit Update, we discussed the new insurance tax credit that is available to tax-exempt employers as a refundable credit or as a reduction of their unrelated business income tax liability. The IRS has released, in draft, Form 8941 (Credit for Small Employer Health Insurance Premiums) for The draft form can be accessed at The final version of Form 8941 (and presumably the instructions) is supposed to be available later this year. Organizations that would like a sneak preview of their potential credit can consult PPC s Guide to Health Care Reform. It offers valuable insights into the calculation of the insurance tax credit. The PPC Nonprofit Update is published monthly by Thomson Reuters/Tax & Accounting, P.O. Box 966, Fort Worth, Texas , (800) COPYRIGHT 2010 BY THOMSON REUTERS/ PPC. Reproduction is prohibited without written permission of the publisher. Not assignable without consent. This publication is designed to provide accurate information regarding the subject matter covered. It is sold with the understanding that the publisher is not engaged in rendering legal, accounting, investment, or other professional advice. If such assistance is required, the services of a competent professional should be sought. Reports on products or services are intended to be informative and educational; no advertising or promotional fees are accepted. Tax & Accounting Research and Guidance P.O. Box 966 Fort Worth, Texas PRSRT STD U.S. POSTAGE PAID Thomson