How to Account for Nonmarket Transactions

A nonmarket transaction is an economic event that creates value but does not involve a direct exchange of cash or occur within a formal marketplace. Although these events lack a clear price tag, they have a tangible impact on an entity’s financial position. The core principle is that an exchange of value has occurred, which requires proper recognition in financial records.

Common Types of Nonmarket Transactions

• Gifts and inheritances are the transfer of assets, such as cash, securities, or property, from one party to another without receiving equivalent value in return. For a nonprofit organization, this often takes the form of donations. These one-sided transfers increase the net assets of the recipient.
• Government services include many goods and services provided to the public that are not sold in a market, such as national defense, public education, and infrastructure. The value of these services is financed through taxation rather than direct user fees. Because there is no market price, their economic contribution is not captured in the same way as privately produced goods.
• Intra-entity transfers are the movement of goods or services between divisions of a single company. For example, a manufacturing division might produce a component used by an assembly division. While no cash changes hands, a resource is transferred, which must be accounted for to ensure accurate divisional performance measurement and inventory costing.
• Household production is the economic value created within households through unpaid labor, such as cooking, cleaning, and childcare. These services have a clear economic benefit and would be costly to purchase. However, they are not included in formal economic measures like Gross Domestic Product (GDP) because they are not traded for a price.

Valuation of Nonmarket Transactions

Assigning a monetary value to nonmarket transactions is a required step for including them in financial statements. The guiding principle is to use fair value, which is the price an asset would sell for in an orderly transaction between market participants. This process ensures that financial reports reflect the true economic substance of these events.

Fair Value Estimation

Fair value is determined by referencing similar items traded in an active market. For example, the value of a donated public stock is its market price on the date of the gift. For other assets, like a used vehicle, valuation involves looking at recent sales of comparable models to find an objective, market-based measure.

Cost Basis

When a market value is not readily available, the cost basis method can be used. This approach values an item based on the accumulated costs required to produce it. For instance, the value of a new public building would be the sum of expenses for materials, labor, and overhead, providing a reliable figure when a market comparison is impossible.

Appraisal

For unique assets like real estate or fine art, a professional appraisal is often required. An appraiser is an independent expert who uses established methodologies to determine an asset’s value, considering factors like the asset’s condition and replacement cost. This formal valuation provides a defensible and credible figure for financial reporting.

Accounting and Financial Reporting

Once a nonmarket transaction is identified and valued, it must be recorded in the accounting system. Proper recording ensures that the organization’s financial statements are complete and accurately represent its financial health and activities.

Journal Entries

Recording a nonmarket transaction follows the principles of double-entry bookkeeping. For example, if a nonprofit receives a donation of equipment valued at $10,000, it would record the event with a journal entry. The entry would be a debit to the Equipment asset account and a credit to the Contribution Revenue account for $10,000.

Impact on Financial Statements

Nonmarket transactions directly affect an entity’s financial statements. Using the previous example, the donated equipment increases total assets on the balance sheet. The corresponding credit to contribution revenue increases the organization’s income on the income statement, which in turn increases its net assets on the balance sheet.

Disclosure Requirements

Generally Accepted Accounting Principles (GAAP) mandate transparency for significant nonmarket transactions. Organizations are required to provide details in the footnotes to their financial statements. This disclosure might include a description of the transaction, the valuation method used, and any restrictions associated with the donated asset.