[WARNING: Reading this article may cause jarring flashbacks for those who did not do well in Accounting 101 in college.  Debits, credits, oh my...]

Accounting isn’t about math.  If you can add, subtract, multiply, and divide, then you can handle 90% of the math in accounting.  It’s accurate to say that accounting is more akin to a foreign language.  Speak the language of the accountant and you’ll be able to communicate ten times better with him or her.  This article is designed to help you understand how your charity’s CFO looks at charitable gift annuities.

Background

First things first.  The language of your CFO is based on Generally Accepted Accounting Principles (“GAAP”).  The rules of GAAP are designed so that anyone reading financial statements can compare apples to apples across companies.  An august organization known as the Financial Accounting Standards Board (“FASB”) has been promulgating accounting rules in the U.S. since the 1970s.  These guys also know how to throw one hell of a kegger.  FASB has devoted an entire section (about 400 pages) in its four-volume Codification for the specialized rules of not-for-profit accounting (although technically all FASB standards apply to not-for-profits).

Your CFO wants to follow GAAP rules so that your charity can get a clean audit report annually from your external auditors.  A bad audit or a major restatement of your charity’s financial statements is the quickest way for a CFO to get fired (that, and embezzling funds).

Accountants follow GAAP in part by making sure that debits equal credits (this is known as double-entry bookkeeping).  Don’t think of debits and credits as “good” or “bad” – but more as the “left” and “right” parts of the accounting equation that makes up each journal entry.

Recording a New CGA

When a planned giving officer secures a new CGA for the charity, several journal entries need to be made on the not-for-profit’s books.  These journal entries are covered by the Revenue Recognition rules in the Split-Interest section of the Financial Accounting Standards and have three basic parts: asset, liability, and revenue.

The asset is the easiest part – it’s whatever the donor gave you to fund the CGA (e.g., $10,000 in cash or $25,455 in stock shares).  The asset is debited here.

Next is the liability.  This is calculated as the present value of the expected annuity payments the charity will have to make over the life of the CGA.  That is calculated using the life expectancy of the annuitant(s), the annuity rate, and a discount rate.  You’ve probably seen this yourself in your planned giving software, but it’s called the “non-charitable portion” or something similar.  The liability is credited here.

Last is the revenue.  This is the difference between the asset and the liability.  If your Accounting Department is using the same set of assumptions as the IRS (as to life expectancy and discount rate), the revenue to the charity will be equal to the charitable deduction that the donor can claim.  The revenue is credited here.

Hence, when the asset = the liability + the revenue, the accounting equation is balanced.  Here’s how it might look on a “ledger entry”:

Category                                 Debit               Credit

Cash Asset      (CGA Fund)    $10,000

Annuity Payable                                             $6,225

CGA Revenue                                                 $3,775

So, in the eyes of your CFO, you didn’t fundraise $10,000 here.  Rather, you fundraised $3,775 and generated a liability of $6,225 for the charity that is now supported by $10,000 in assets.  We all probably know in the back of our heads that the face value of a CGA doesn’t represent the true gift to the charity, but rest assured CFOs most certainly see it that way.

One final, but ESPECIALLY important point when recording a new CGA.  Your CFO may use a different, often more conservative, set of assumptions than the IRS when calculating the liability.  That may mean using longer life expectancies and/or a lower discount rate.  Either of those will result in a larger liability and hence, a lower figure for the revenue generated from the transaction.

Annual Adjustments for Distributions and Valuations

Two things happen over any year where the CGA annuitant doesn’t die.  First, annuity payments are made to the annuitant.  This has the effect of lowering your assets (cash, in this case) and also lowering the CGA liability.

The ledger entries might look something like this on a distribution of $500 to the annuitant:

Category                                 Debit               Credit

Annuity Payable                     $500

Cash Asset (CGA Fund)                                 $500

If the annuitant is paid quarterly, that ledger entry is going to be made four times over the course of the year by your Accounting Department.

Second, under the GAAP rules, the charity is required to revalue both its assets and liabilities at the end of each fiscal year.  Those assets you have invested in stocks and bonds to make the annuity payments are going to pay out dividends/interest and appreciate or depreciate in value over the course of the year.  Additionally, the CGA liability will need to be adjusted given changes in the annuitant’s life expectancy.

Here are some ledger entries that might result:

1. One of the stocks in your CGA fund pays out a $100 dividend.

Category                                 Debit               Credit

Cash Asset (CGA Fund)         $100

Investment Income                                         $100

Note: Investment income is NOT considered fundraising revenue, so it generally isn’t counted towards the annual campaign.  However, it does affect the bottom line and what your charity has available to spend.

1. At the end of the fiscal year, one of the stocks in your CGA fund has appreciated in value by $2,500.  

Category                                             Debit               Credit

Stock Asset (CGA Fund)                    $2,500

Change (Gain) in Investments                                    $2,500

Note: This entry increases the value of the stock and recognizes a gain (which is sort of like revenue, but beyond the scope of this article).  Alternatively, if the stock dropped $2,500 in value, the entries would be reversed with a debit of $2,500 to Change (Loss) in Investments and a credit of $2,500 to the Stock Asset.  This procedure is commonly called “mark-to-market” in accounting parlance.

1. At the end of the fiscal year, the CGA liability is recalculated and determined to have increased by $600.  Remember the CGA liability was decreased over the year whenever a payment was made, but now that the annuitant has lived one more year, his/her life expectancy has inched upwards.

Category                                                                                 Debit               Credit

Change in Value of Split-Interest Agreements                       $2,500

Annuity Payable                                                                                             $2,500

Note: These entries could be reversed as well if the liability is recalculated as having decreased (which would happen in a two-life annuity scenario once the first annuitant dies).

Termination of a CGA

The day has finally come, fourteen years after the planned giving director secured that CGA, our dear donor/annuitant has passed away.  It’s a sad day for the planned giving director, but the CFO is thrilled that they finally get to “release” the funds for spending and close out the accounting entries on the CGA.

Let’s suppose at the beginning of the fiscal year, the CGA Liability was valued at $900 and no distributions were made to the annuitant in the year he/she passed away.  The first thing the CFO needs to do is close out the liability.  This happens by debiting the liability and crediting Change in Value of Split-Interest Agreements.

Category                                                                                 Debit               Credit

Annuity Payable                                                                     $2,500

Change in Value of Split-Interest Agreements                                               $2,500

Note: This “zeroes out” any remaining liability associated with this particular CGA.

Second, the assets that were being held to make payments on the liability (which have been calculated at $3,200 in this example) are “released” from the CGA Fund and transferred into the General Fund where they are available for spending.

Category                     Debit               Credit

Cash (General Fund)  $3,200

Cash (CGA Fund)                               $3,200

Note: This “release” may also be a reclassification from Temporarily Restricted Funds (time-restricted) to Unrestricted Funds – but that’s a story for another day.

A Final Word on All Ledger Entries

Although your Accounting Department could make these various and sundry entries for each and every individual CGA, the reality is that they are more likely to calculate them on the CGA fund as a whole and make a single, “combined” entry once a quarter or even just once a year in the case of releasing funds at termination.

Why CFOs Don’t Always Like CGAs and How to Counter That

As you can see, accounting for a CGA on a charity’s books involves many journal entries over the life of the CGA and numerous annual revaluations.  Throw in the fact that individual CGAs can go “under water” and additional entries need to be made if any CGA is reinsured, and it can be a lot of work for what might seem like a relatively minor return in the CFO’s eyes.  A short-sighted CFO, focused only on this year’s financial statements might determine that he or she doesn’t really like or see the point of the charity issuing CGAs.

Here's the rub and what you need to convey to the CFO (and you already know this).  Acknowledge that the immediate financial return (especially if your charity places 100% of the donated assets into a CGA fund) isn’t going to be the highlight of the Annual Report.  Also acknowledge that you understand dealing with CGAs for your Accounting Department isn’t just slapping them on the books and forgetting about them until the annuitant passes away.

However, the payoff can be both indirect, in the future, and more importantly, BIG.  We all know that CGAs donors are often the most engaged planned giving donors we have.  They often do multiple CGAs.  We talk to them regularly and steward the heck out of them.   That stewardship is likely to result in any of the following: an outright major gift, an assignment of their annuity interest back to the charity, and best (i.e., biggest) of all – a bequest when they pass away.  In other words, CGA donors aren’t “just” CGA donors.

CGA donors are not only more likely to leave a bequest to your organization, than say, a donor to your gala or direct mail; the bequests they leave are on average larger than bequests from the average (non-CGA) donor.  At my organization, we’ve found that donors that have a planned gift commitment leave bequests TWICE the size of the average bequest and when that planned gift is a CGA, the bequest is FOUR TIMES the size of the average bequest.  Now that’s getting some bang for your buck that even the most conservative of accountants can get behind.

For further reading about non-profit accounting, I suggest the following:

Beginners: Not-for-Profit Accounting Made Easy by Warren Ruppel.

Intermediate and for Insomniacs: Wiley’s Not-For-Profit GAAP (published annually by Wiley).

True Gluttons for Punishment: Section 958 in Volume 4 of the Financial Accounting Standards Board (FASB) Codification of Accounting Standards.