Nonprofits will be facing many changes in the upcoming year when it comes to revenue and contribution recognition. For fiscal years ending December 31, 2019, these revenue and contribution recognition standards will need to be followed by all nonprofits. These changes may result in more grants being considered conditional rather than unconditional.
The first step that should be done is to determine whether or not a transaction is revenue (exchange transaction) or if it is a contribution. A revenue transaction is a transaction where each party in the contract directly receives commensurate value. If both parties do not receive commensurate value, then it would be considered a non-exchange transaction, or a contribution.
If it is determined that a transaction is a contribution rather than revenue, some additional steps need to be followed to determine the timing of the recognition. An analysis of conditional versus unconditional contributions should be performed. A conditional contribution would result in contributions being recognized as conditions are met and an unconditional contribution would result in contributions being recognized when the contribution is made. Several steps that need to be followed when making this determination. If any of the following result in a “no” answer, then the transaction can be considered unconditional, and the full amount of the transaction can be recognized:
- Is there a barrier?
- Is there a right of return?
- Is the right of return directly related to the barrier?
Although there are only three steps involved, these three steps require a bit more knowledge in order to understand what a barrier and a right of return are.
What is a barrier?
A barrier is an item that contains measurable performance-related outcomes. Examples of measurable performance-related barriers include a requirement that indicates that a recipient’s entitlement to transferred assets is contingent upon the achievement of any of the following:
- A specified level of service
- An identified number of units of output
- A specific outcome
What is a right of return?
A right of return is usually a clause written within the grant that says the grantor has the right to request a return of funds from the grantee or to withhold payment to the grantee.
Linkage of Right of Return and Barrier
This is perhaps the most important and the most difficult determination when it comes to the conditional versus unconditional contribution analysis. The right of return of funds must be directly linked to the barrier(s) in the grant. If there are stipulations within the grant that says the grantor can request a return of funds “for all of the conditions within this grant”, then it doesn’t mean the right of return is directly linked to the barrier. The grant would have to say something along the lines of “The grantor may request a return of funds if outcome #1 is not achieved”.
What does all of this mean?
There may be fewer contributions recognized on a yearly basis due to this new accounting standards update.
What changed from the previous standard?
The previous standard added another element to this analysis. If the likelihood was more than remote (i.e. probability assessment) that the condition would not be met, then this may have resulted in a conditional grant. This new accounting standards update eliminates that element as a consideration. The result is less judgment-based and more bright line guidance (in theory). If there is a condition and a directly connected right of return, then you recognize the grant only when the barrier or condition is actively met or overcome.
Call to Action
Organizations should review their grants for conditions, barriers and right of returns. If you have any questions or would like some guidance on determining whether a grant is conditional or unconditional, please contact our Nonprofit team.
By Dan Pare