Revenue Recognition for Not-for-Profit Industry
June 13, 2018
With the 2018 effective date for the new revenue recognition standard issued by FASB quickly approaching, SC&H Group has pulled together a comprehensive series of industry specific resources. The following blog post summarizes revenue recognition concepts specific to nonprofits that must be considered to ensure their accounting policies are aligned with the FASB’s new standard.
The new revenue recognition standard update provides a five-step approach for recognizing and measuring revenue. This post considers some of the considerations for not-for-profits. Common not-for-profit revenue streams that could be impacted include revenue from membership dues, subscriptions, products and services, sponsorships, conferences and seminars, special events, advertising, royalty agreements, tuition, boarding, and meal plans. The Financial Reporting Executive Committee (FinREC) has specially addressed several industry topics in its working drafts on the new revenue recognition standard. Below is a high level summary of the five steps.
Identify the contract with the customer
A contract exists if collection is probable, rights to goods and services and payment terms can be identified, it has commercial substance, and the contract is approved and parties are committed to their obligations. A contract can be written, oral, or implied by an organization’s ordinary business practices. It must now be probable that the organization will collect the consideration from the customer (i.e., ability and intent to pay) to recognize revenue. When assessing customers’ ability to pay, include payments from all sources. An educational institution, for example, would consider financial aid for a student’s tuition even if the funds were coming from other sources.
Contribution revenue is not effected under this update, as it is not considered a contract with a customer. A donor is not a customer as there is no reciprocal exchange transaction.
Grant Revenue: The FASB has issued an exposure draft for proposed guidance that would assist organizations in determining the proper revenue recognition for grants, as well as whether a contribution is conditional. An organization receiving a grant must determine if it is a reciprocal exchange transaction or a contribution. If the activity that the grantor funds is planned and carried out by the not-for-profit, and the not-for-profit has the right to the benefits of the activity, it is likely a contribution. However, if the grantor receives commensurate value, then the asset transfer is an exchange transaction. Often a grantor will receive the benefit of societal benefit, but this does not trigger reciprocal exchange, even if the societal benefit furthers the grantor’s mission.
There are certain indicators to assist in determining if funds received by a not-for-profit organization are a contribution or an exchange transaction.
(A) Solicitation motive: Consider whether the organization solicited funds as a contribution or as a resource for which it would provide specific benefits.
(B) Resource provider’s intent: Determine if the resource provider specified that the intent was a donation or that it providing resources in exchange for specific benefits.
(C) Method of delivery (timing, location, etc.): If the resource provider stipulates the method of delivery, it is an indicator of an exchange transaction.
(D) Determining the amount: A resource provider typically determines the amount of a contribution on their own. In an exchange transaction, both parties would likely agree on an amount that is based on the value of the assets/benefits to be provided.
(E) Penalties: Penalties that are limited to the organization paying back unused funds or not receiving additional funds indicate a contribution. Economic penalties beyond the amount of payment indicate an exchange transaction.
(F) Benefit recipients: If assets, services, or other benefits are to be delivered to an entity other than the resource provider or those closely related to the resource provider, this is an indication of a contribution.
Identify the performance obligations in the contract
A performance obligation is the promise to transfer a good or service to the customer. Determine whether the performance obligations in the contract are distinct or should be bundled. Consider factors such as the pattern of transfer, if the customer can benefit from it on its own or with other resources readily available to the customer, customization needed, inter-relatedness, etc.
Not-for-profits often have revenue contracts with multiple components, which may have a mixture of contributions and exchange transactions, such as membership dues, sponsorship agreements, or special event tickets. Schools will need to determine if tuition and housing should be combined based on certain criteria. FinREC believes that in most cases, tuition and housing are distinct services which would be separate performance obligations.
Bifurcation of Transactions between Contribution and Exchange Components has been addressed by FinREC. If any Accounting Standards Codification (ASC) topics other than Topic 606 Revenue from Contracts with Customers specify how to separate parts of the contract, the organization should first apply those topics. This means that specific bifurcation guidance in ASC 958-605-55 Not-for-Profit Entities Revenue Recognition Implementation Guidance and Illustrations should be applied first, before the new revenue guidance, to separate the contribution portions.
Determine the transaction price
The transaction price is calculated as the amount of consideration the organization expects to be entitled less amounts collected by the organization on behalf of a third party (such as sales tax). It includes an estimate of variable consideration to the extent that a significant revenue reversal is not probable. While collectability is considered in determining if a contract exists (step 1), it does not affect the transaction price.
An institution that provides discounts to their customers for a distinct good or service (for example, an employee of a financial institution receives a tuition remission for their child to attend), the expense would have the same functional classification as the cost of goods or services. If the financial aid is not awarded in exchange for a good or service, as in the case of a typical scholarship granted to a student, the transaction price would be reduced.
Educational institutions often have a period of time that a student could withdraw and receive a full or partial refund. If an institution receives consideration but expects to refund any of it, it is considered a form of variable consideration and a refund liability would need to be recognized. The refund liability should be estimated using either the “expected value” method or the “most likely amount” method, typically at the portfolio level, possibly using probability estimates and historical trends.
Allocate the transaction price to the performance obligations in the contract
Management must allocate the transaction price to each distinct separate performance obligation based on the relative standalone selling price of each obligation. The best evidence of a standalone selling price is the price management would charge when the organization sells it separately.
Recognize revenue when (or as) the entity satisfies a performance obligation
Revenue can be recognized when (or as) a performance obligation is satisfied, which is when the control of the product or service is transferred to the customer. The customer obtains control when they 1) can direct its use and 2) obtain substantially all remaining benefits from the product or service.
For each performance obligation, consider whether revenue will be recognized over time or at a point in time. An organization satisfies a performance obligation over time if one of the following is met: (A) the customer simultaneously receives and consumes the benefits provided by the organization’s performance as the organization performs (as would generally be the case for tuition and housing); (B) the organization’s performance creates or enhances an asset that the customer controls as the asset is created or enhanced; or (C) the organization’s performance does not create an asset with an alternative use to the organization, and the organization has an enforceable right to payment for performance completed to date.
There is an option to use a portfolio approach as a practical expedient. An organization may apply the guidance to a portfolio of similar contracts or performance obligations to apply a set of assumptions and estimates on a portfolio level, instead of each individual contract. For example, an educational institution considering collectability or refunds could be done for a group of tuition contracts instead of on an individual student by student basis.
On the statements of financial position, the organization should record a contract asset or contract liability depending on the relationship between its performance and the customer payment. A contract asset would represent a right to consideration for performance obligations delivered. A contract liability would represent its contract obligation when it has received consideration (or an amount of consideration is due) from the customer. For example, when an educational institution receives a nonrefundable deposit from a student to secure housing or enrollment, the institution must record a contract liability. A contract asset or receivable will be recognized if the institution provides the tuition or housing service before the student pays (or has an unconditional obligation to pay). The use of alternative descriptions are permitted, so organizations can continue to use their standard terminology (deposits, prepayments, deferred revenue, etc.).
On the statements of activities, the organization would not present gross revenue because revenue is recognized based on transaction price, however, revenue reductions such as financial aid or scholarships could be reported parenthetically on the statements or in the footnotes.
An organization should disclose sufficient information to enable users of financial statements to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. Qualitative and quantitation information is required about:
- Contracts with customers—including revenue and impairments recognized, disaggregation of revenue, and information about contract balances and performance obligations (including the transaction price allocated to the remaining performance obligations).
- Significant judgments and changes in judgments—determining the timing of satisfaction of performance obligations (over time or at a point in time), and determining the transaction price and amounts allocated to performance obligations.
- Assets recognized from the costs to obtain or fulfill a contract.
Nonpublic entities are required to adopt the new standard for annual reporting periods beginning after December 15, 2018 (December 31, 2017 for public entities). Implementation is to be done on a retrospective basis, so organizations should understand and account for revenue under the new standard at least a year in advance.
As a result of these standards entities need to reassess their current revenue accounting and determine whether changes are necessary. SC&H Group is here to help as you are navigating the best next steps to pursue. If you have any questions about revenue recognition specific to not for profits please Contact Us.