Programmatic Investments
Posted by: V.Weber
Programmatic investments exist to further not-for-profit mission as opposed to return on investment. Not-for-profit organizations can invest in a startup to support the mission of the startup or provide guarantee of the funds to an entity that won’t be able to pay it back. There are various types of programmatic investments with the most common being:
- Loans
- Equity interests
- Guarantees
Loans are the most common programmatic investment and typically are used to provide resources to low-income households. Typically, the interest rate offered by the not-for-profit organization is a lot lower than an interest rate offered by a bank. So, when recording a loan on not-for-profit books the accountant needs to think about the interest rate, expectation to collect (does the not-for-profit organization expect to collect any of the funds back) and potential for forgiveness.
Accounting for loans (programmatic investments) nonprofit organizations
There are three ways programmatic investment loans can be recorded: a) receivable; b) contribution; c) split between receivable and contribution. If the not-for-profit organization expects to collect all the funds and is getting some kind of interest on this loan – then recording such loan as a receivable is appropriate accounting treatment. If the not-for-profit organization doesn’t believe that the loan will even be collected, then the entire loan can be recorded as a contribution. There could be a situation when a combination of the two would be appropriate as well (recording a portion of the loan as a receivable and a portion of the loan as a contribution).
Below market interest
If there is no interest on the loan or the interest rate is significantly below the market rate – not-for-profit organizations would have to impute the interest rate. So, in this case there would be a contribution expense recognized for the difference between the net present value (NPV) and the amount transferred. When interest rate is below the market, loan receivable can be recorded in one of the following two methods:
- Effective interest rate method
- Inherent contribution method
Both methods get to the same net outcome with the difference being in presentation.
Effective interest rate method of accounting
Using the effective interest rate method at the initial measurement date a loan receivable would be recorded at the amount provided to the recipient with a corresponding credit to cash for that same amount provided. Then for the amount of the imputed interest contributed expenses is recorded (debit to contribution expense) – the amount of the difference between the present value of the loan and the amount paid out. The opposite side of the entry would be discount on loan receivable (credit side of the entry) for the same amount. The following journal entry would be made:
| Dr. | Loan Receivable | $100,000 |
| Dr. | Contribution Expense | $20,000 |
| Cr. | Discount on Loan Receivable | $20,000 |
| Cr. | Cash | $100,000 |
The discount on loan receivable would be amortized every year and would be presented net of discount on the statement of financial position (balance sheet). The Following entry would be made to account for amortization of the discount:
| Dr. | Discount on Loan Receivable | $1,000 |
| Cr. | Interest Income | $1,000 |
These are the entries that related to effective interest rate method load accounting as it relates to programmatic investments. Now let’s take a look at the inherent contribution method.
Inherent contribution method of accounting
We are not going to record a discount on loan receivable and the loan is not going to be recorded net of discount. There would be a loan receivable that would be recorded at the amount of cash provided to the recipient minus the contribution expense amount. Using this method of accounting the following journal entry would be made at an initial measurement date:
| Dr. | Loan Receivable | $80,000 |
| Dr. | Contribution Expense | $20,000 |
| Cr. | Cash | $100,000 |
And subsequently, interest income would be recorded on an annual basis by debiting loan receivable and crediting interest income:
| Dr. | Loan Receivable | $1,000 |
| Cr. | Interest Income | $1,000 |
In this case, the not-for-profit organization is expecting to be repaid of the loan that has a below market interest rate. So one the loan is paid the following journal entry would be made:
| Dr. | Cash | $80,000 |
| Cr. | Loan Receivable | $80,000 |
In a situation when the not-for-profit organization is not expecting to get repaid back – then the entire amount is recorded as a contribution with no loans sitting on the books. If the not-for-profit organization is expecting to receive a partial payment – then the loan is recorded just for that expected amount. For example, if a loan of $100,000 was made to a qualified individual and it is expected that the individual will be able to pay back $50,000, then loan receivable would be recorded for the amount of $50,000 with the difference between the loan receivable present value and future cash flows would be recorded within contribution expense. One last important this to note on this topic is that allowance for doubtful accounts is not recorded for these types of loans.
AICPA Audit and Accounting Guide has a great flowchart that helps to visualize and evaluate the process of recognition and accounting.
Source: AICPA Audit and Accounting Guide: Not-for-Profit Entities -> Chapter 8 — Programmatic Investments -> Loans -> Inherent Contribution Approach
Forgiveness of the programmatic investment loans
When a not-for-profit organization is expecting to forgive the loan in its entirety – this constitutes a condition (a forgivable student loan could be an example of this). In this scenario the condition (or barrier) must be overcome, as this is considered a conditional contribution . A receivable would be debited, and cash would be credited until the condition has been met. When the condition is met then the contribution expense is being recognized and the receivable is being reversed out. So, the following journal entries would be made at the initiation:
| Dr. | Loan Receivable | $10,000 |
| Cr. | Cash | $10,000 |
Then, as the condition (or barrier) is met the following entry is made:
| Dr. | Contribution Expense | $10,000 |
| Cr. | Loan Receivable | $10,000 |
There is a difference between forgiveness and impairment and involved professional judgment for determination. The general rule is when there is a change in probability of collection – there is loan impairment as opposed to forgiveness. So, a good rule for thinking about this is if at the inception the organization was expecting to get the loan repaid back – and it ended up not being repaid – then it’s an impairment. On the other hand, if the organization was not expecting the loan to be repaid at the onset – then it’s a forgiveness situation.
Conclusion
In this article we briefly reviewed some of the key factors related to programmatic investments. This topic is very deep and has a lot of nuances to it, navigating the world of programmatic investments can be a quite complex task. It is of paramount importance to have proper accounting for programmatic investments and investment-related transactions for financial statements presentation. If you need additional guidance on this topic – be on the lookout for future articles related to this topic. If you need help with not-for-profit accounting from a not-for-profit CPA – do not hesitate to contact us directly. At WCC we specialize in not-for-profit accounting, and it is our mission to help mission-based organizations to achieve their mission.