Translating for-profit language into the nonprofit world can sometimes lead to confusion. When accounting regulations using terms like “customers” and “contracts” apply to organizations of all types, it may leave nonprofit leaders scratching their heads as to how to apply revenue recognition rules accurately. To help with this problem, a significant update- which includes clarifying language for transactions – was issued by the Financial Accounting Standards Board (FASB) Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers.
The FASB’s 2014 update was intended to simplify nonprofit revenue recognition accounting and more closely align the US’s standards with international accounting standards. Unfortunately it left many industries, particularly the nonprofit industry, with additional questions. The title alone has many nonprofits wondering, “Do I have customers?” and “Do I have contracts”? These new revenue recognition rules didn’t seem to speak to nonprofits, which are not focused on providing value to specific customers, but to society as a whole.
After years of debate and further consideration, the FASB issued ASU 2018-08, Clarifying the Scope and Accounting Guidance for Contributions Received and Contributions Made. The goal of this accounting standard is to help reduce confusion about what constitutes a revenue transaction, and to reduce diversity in practice in how entities classify their grants and other similar contracts from various types of resource providers. ASU 2018-08 provides clearer guidance on when a transaction is a contribution or a revenue transaction, which will result in differences in the timing of recognizing the transaction. While this new guidance affects nonprofit entities most significantly, it is applicable to any business entities that receive or make contributions of cash or other assets, including promises to give.
The most significant amendment to the revenue recognition rule is determining whether a transaction is an exchange transaction. An exchange transaction is defined when the entity providing goods or services (the resource provider) is receiving commensurate value in return for the goods or services transferred, and therefore, would qualify the transaction as a revenue generating transaction. The amendment specifies that commensurate value does not include any benefit received by the public, execution of a resource provider’s mission or the positive sentiment from acting as a donor. To qualify as a revenue transaction, there must be a specific identifiable customer receiving the benefit. Here’s a clarifying example:
• If a pharmaceutical company finances the costs of a cancer study at a nonprofit research university when the pharmaceutical company retains the rights to the results of the study, this could be considered an exchange transaction, which would mean revenue to the university and an expense to the pharmaceutical company.
• However, if the same university receives a private grant to perform a study for the benefit of the public good, this could be considered a contribution to the university and to the grant foundation.
The amendment also distinguishes that there may be transactions which could appear to have elements of both an exchange transaction and a contribution. Examples include payments under Medicare and Medicaid programs, provisions of health care or education services by a government for its employees, and Pell grants or similar state or local government tuition assistance programs. In these instances, an organization may have a contract with a customer, such as a contract to provide tuition to a student or medical services to a patient, and the payments made from another source would simply be payments made on behalf of those customers.
Accounting for Contributions: Conditional or Unconditional
This amendment clarifies accounting for contributions and helps organizations determine whether a contribution can be considered unconditional or conditional. If a donor-imposed condition exists, an organization is not able to recognize the contribution until the barrier is overcome. Here are some key terms to understand:
• A donor-imposed condition must have both one or more barriers that must be overcome before the organization is entitled to the contribution and a right of return or release of obligation to the contribution (or for a reduction, settlement, or cancellation of liabilities) to the donor for the contribution.
• Barriers can include measurable performance-related barriers, such as providing a specified level of services, an identified number of units of output or a specific outcome, or restrictions which give the recipient limited discretion on conduct of an activity.
• Limited discretion could include a requirement to follow specific guidelines about incurring qualifying expenses, a requirement to hire specific individuals as part of the workforce conducting the activity, or a specific protocol that must be adhered to.
• A donor-imposed condition is different from a donor-imposed restriction, which may limit the use of the contribution for a specific activity or time frame but would not preclude the organization from recognizing the contribution.
This new standard introduced plenty of new considerations for nonprofit organizations and business entities alike to think about as they enter into contribution and exchange transactions. While it hopefully provides a more consistent framework, there is still plenty of room for questions about how to classify individual transactions. This standard aligns with ASU 2014-09, Revenue from Contracts with Customers, which means it is effective now for any transactions in which a public business entity or certain nonprofit organizations which have issued public debt is a resource recipient, and effective December 15, 2018 if the public entity is a resource provider. For nonpublic entities, this standard is effective December 15, 2018 for resource recipients and December 15, 2019 for resource providers. This also coincides with the new financial statement presentation guidance for nonprofit entities, so 2019 could mean many changes for nonprofit organizations. For help applying this standard to your nonprofit organization, contact the leader of our nonprofit practice, Bob Hart today.
Written by Alicia Raspa