When a company makes a donation or sponsors an event, the last thing on their mind is the accounting and tax implication of such transactions. If done by way of cash contributions the answer is simple, it’s a general and administrative expense. Technicalities do exist, but the solutions to such situations tend to be easy to figure out.
As I have come to find out, the situation isn’t quite that simple for many of my clients. For construction entities, donations of materials or services is the primary driver of any significant charitable contributions. This is often the result of unused materials for a contract or downtime among the staff that the company thought was better used for a charitable purpose. These occurrences happen often enough in the past, but recent supply chain impacts have made many companies take an aggressive stance in ensuring that they have enough materials to complete their in process jobs. Naturally, this action can lead to higher amounts of unused materials. COVID-19 delays has also caused significant difficulties in scheduling labor on contracts resulting in higher downtime.
At this point in the process, the common questions that we get are a mixture of the following:
- What exactly are the debits and credits?
- Is there any benefit of us doing this?
- Who should we donate to?
- Is this even legal?
To briefly answer that last point: yes, it’s legal. For other points above, a deeper dive is required.
With COVID-19 and the related supply chain issues, there has been a concerted effort by many entities to stay ahead of the upcoming construction phases. Most notably, companies are front-loading the job with materials instead of relying on a more just-in-time approach as was commonly practiced. This has led to aggressive sizing of the orders and exposure of the ordered materials to be subject to change in scope. The ultimate result is unused materials for contracts that the Company now has to contend with. Returning these materials to the vendor for a refund/future credit or utilizing it in a different contract is probably the ideal outcome in these instances (some contracts may also require turning over the unused materials to the GC/Owner).
However, more and more, there are vendors who stipulate that the materials are not subject to return or refund citing the supply chain matters and COVID-19. In these instances, the Company is left with few options:
- They can store it in their warehouse in hopes of using it in the future (consideration needed for inventory)
- Auction the materials or scrap the materials
- Donate the materials
The accountant in me would suggest either storing the materials for the future or auctioning the materials. Once those options are exhausted, donating the material becomes the next logical choice. However, there is a bit more to consider before hauling all the items to the nearest donation center.
The accounting impact of donating $100,000 of unused material on a contract is the following:
In the instance that the same $100,000 of donated materials are currently included in inventory.
The ugly truth of the matter is that from the purely numbers perspective, donating the materials is only a mild step-up from doing nothing. The justification for the accounting treatments above can be summed quite simply: there is no other option.
Due to the initial expenditure made for the purchase of materials, no additional cost can be recognized for the Company for the same material. The only option remaining for this in-kind donation is to essentially move the would be cost of revenue or obsolete inventory cost to a G&A expense in form of Charitable Contribution. In fact, for pass-through tax purposes, this might result in a net negative as the recipient of the charitable credit (by Form Schedule K-1) may be subject to limitations on their Form 1040.
Another item to be aware of is when donating materials that was charged previously to a time-and-materials contract or a cost-plus contract, there is a non-zero chance that you would be in violation of certain contract clauses and be subject to claw-back of the cost and margin charged for said materials.
If still, you consider that benefits of donating the materials outweighs the drawbacks, or that it is just the right thing to do, the donations must be made to an eligible charity that holds a tax-exempt status. The not-for-profit status of an organization can be verified using the IRS website found here.
Stay tuned as the second part of this blog will include the treatment of in-kind donation in form of labor.