Discounting Pledges (avoiding management letter comments, part 3)

Discounting pledges and accounts receivable can be a confusing topic, so it shows up often as a management letter comment.  Depending on the amount requiring adjustment, this can be either a significant deficiency or a material weakness if it gets too big. Below are some suggestions on how to record pledges and discounts, and avoid getting a management letter comment.

• Pledges should be recorded as revenue when there is substantive proof of intent, a signed pledge card or email.
• Pledges not expected to be paid for more than one year should be discounted for time value.

There are two ways to determine the rate used for discounting:

• Use a rate equivalent to the rate you would receive if you were borrowing the funds from a bank; or

• Determine the risk free rate at the date of the pledge and the length closest to the term of the pledge by using this website http://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yieldYear&year=2011.  If you choose this route the rate will need to be adjusted for your organization’s personal level of risk by increasing the risk-free rate an additional amount as deemed appropriate by management. Increases from 0.5% to 1.0% are common. When interest rates increase, these risk-adjustments will also increase.  The longer the term of the pledge the higher the additional rate of risk should be.

Example: For a pledge received 10/14/11 due over the next 5 years, using the treasury rates, the based amount is the risk free rate of 1.12% plus your rate of risk adjustment.

A schedule can be set up in Excel to calculate the Present Value discount using the PV formula and the rates you’ve determined which will automatically calculate the PV discount each year.  Please contact us if you need help with this.

The entry to record the discount at the time of the receipt of pledge would look like this:

The discount is a contra account against the receivable. The pledge is recorded at the full balance indicated by the donor. The revenue represents the present value of the pledge.

The following entry would be made to remove the discount as time elapses:

Pledges and accounts receivables that have been outstanding for multiple years with no payments on them may need an allowance for uncollectible pledges. This is a contra account against the pledge receivable. The other side of the entry hits bad debt expense.

The amount of the allowance is based on the likelihood that payment will be received based on managements analysis of history with that donor and any communication (or lack thereof) with them.

If you feel the pledge/account receivable will never be paid it should be written off to the allowance account in full.

These are just suggestions. If you feel you have a unique setup and need help deciding how to record and discount your receivables, please feel free to contact us.  Part of our job is to help you help yourself.

This is part 3 of a continuing series on common management letter comments.  Click here to read part 1 and part 2.

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