Steps to Help Not-for-Profits Scrutinize their Revenues for Impact from Recent Accounting Standards
The time has come for many not-for-profits to incorporate ASC 606 Revenue from Contracts with Customers in their GAAP financial statements. This overhaul to the model of recognizing revenue with customers has left many questioning what funding qualifies as “customers” within that guidance.
Answering that question requires the guidance of another accounting standard applicable to not-for-profits that are the recipients of grants and other contracts from governments and other funders. Before jumping into ASC 606, make sure to start with accounting standards update (ASU) 2018-08, Clarifying the Scope and Accounting Guidance for Contributions Received and Contributions Made, to determine if a transaction fits the definition of a contract with a customer for ASC 606 application.
Step 1: Distinguish if both parties are giving and receiving something of equal value (exchange transaction)
In the retail world, this is often an easy determination to make. For example, I pay $10 for a movie ticket. We call this direct commensurate value in accounting terminology when equal benefit (i.e. watching a movie) is received by me, the resource provider, in return for the resources transferred to the other party (i.e. $10).
Not all transactions are this straightforward when determining direct commensurate value between a resource provider and a not-for-profit. It’s critical for not-for-profits to determine if their grants and contracts qualify as exchange transactions by considering who is receiving the benefit of its services. The guidance in ASU 2018-08 clarifies whether the resource provider is receiving commensurate value in return for the resources transferred. Important factors to note are:
- A resource provider (including a foundation, a government agency, or other) is not synonymous with the general public. A benefit received by the public as a result of funding provided is not equivalent to commensurate value received by the resource provider. For example, a private foundation funding career training for adults does not constitute direct commensurate value to the private foundation.
- Execution of a resource provider’s mission or the positive sentiment from acting as a donor does not constitute commensurate value received by a resource provider for purposes of determining whether a transfer of assets is a contribution or an exchange transaction.
- If the penalties assessed on the recipient for failure to comply with the terms of the agreement are limited to the delivery of assets or services already provided and the return of the unspent amount, the transaction is generally indicative of a contribution. If terms of the agreement involve further economic penalties in the case of nonperformance, then it generally indicates the transaction is an exchange of commensurate value.
Government grants to fund programs for the general public or a certain population may have been treated as exchange transactions for reporting purposes in the past. This new guidance clarifies that if the government is not receiving direct commensurate value in return, then it is treated as a contribution and not an exchange transaction.
Consider, too, arrangements where governments or other third parties make payments on behalf of others, as is the case with Medicare insurance payments to hospitals for qualifying patients. In this scenario, the patient has a contract with the hospital to pay for services and the hospital is providing those services to the patient (exchange transaction). Although the government is the primary source of funding for that patient’s care, amounts collected from Medicare are treated as a payment against the existing patient contract revenue and would not create additional revenue, nor be a contribution or exchange transaction with the hospital.
Should I go to Step 2?
If both parties in the transaction are receiving direct, equal value in a transaction where consideration is exchanged, then stop here and follow ASC 606 guidance for that arrangement. If not, it is a nonreciprocal transaction that requires further consideration under ASU 2018-08 for proper recognition. Remember that a single transaction may be in part an exchange transaction and in part a contribution. For example, a not-for-profit gives its donors $50 in merchandise for a $100 donation. In this arrangement, the exchange and nonexchange portions of the $100 transaction are separately analyzed under the framework.
Step 2: Are there donor-imposed conditions on the contribution?
Once the grant or contract is determined to be a contribution, then further consideration of conditional or unconditional is required. This step impacts the timing of when that revenue is recognized. Unconditional contributions are recognized immediately whereas conditional contributions are recognized once the condition has been met. So, what creates a condition? There are two factors, both of which must be present in the agreement for a contribution to be conditional:
- Includes a barrier to entitlement for the recipient to overcome, and
- Includes a right of return of the assets transferred or a right of release of the promisor’s obligation to transfer the assets.
The factor concerning a right of return or release is often in grants as a general stipulation to funding. Having that right explicitly stated in an agreement, regardless of the probability of the funder calling on that right, supports the presence of a conditional contribution. Often the biggest judgment for determining whether a contribution is conditional relates to barriers. Indicators of barriers should be considered based on the circumstances of the particular grant, with no one indicator determinative. The indicators include:
- Recipient must achieve a specified, measurable performance or other outcome. Examples include stipulations to train 200 veterans, expand a facility by at least 2,000 square feet, or hold an annual gala. Keep in mind that the likelihood of the recipient meeting the performance or other outcome is not factored into the conclusion of its presence.
- A stipulation limits the recipient’s discretion on the conduct or the time frame of an activity. An example is incurring qualified expenses that are based on specific requirements or cost principals, such as allowable costs.
- A stipulation is related to the primary purpose of the agreement. For example, reporting on research findings on a grant for basic research. The accounting standard addresses that administrative and trivial stipulations, such as reports on how funds were spent, progress reports, or an annual financial statement audit requirement, do not constitute a barrier under this definition.
It may be difficult to determine whether ambiguous donor stipulations equate to conditions. In these circumstances, contributions containing stipulations that are not clearly unconditional shall be presumed to be conditional contributions.
Step 3: I’ve determined the contribution is unconditional. What’s next?
If a contribution has been deemed unconditional, the not-for-profit then considers whether the contribution contains a donor-imposed restriction for how or when the funding is used. If there was no right of return or release in Step 2 above to make the contribution conditional, there still may be a restriction attached to the contribution that the not-for-profit must track for proper accounting and reporting.
The following decision tree summarizes the content above.
Financial Statement Impact Reminders
Remember, the terms used in financial statements to label revenue is not a factor for determining whether an agreement is within the scope of the guidance. Contribution revenue may be presented in a not-for-profit’s financial statements using various terms (i.e. gifts, government grants, grants and contracts, or other terms). There is no requirement to label grants and contracts that fall under this guidance as “contributions” for financial reporting. Not-for-profits are encouraged to continue using appropriate labels to present their revenues.
Accounting guideline require disclosures of conditional promises to give, that is, amounts not yet received, for which the conditions have not been met as of the reporting date. For these agreements, the total of the amounts promised and a description and amount for each group of promises having similar characteristics must be disclosed in GAAP financial statements.
Regardless of where you currently stand in your implementation of the new revenue recognition guidance, Barnes Dennig can provide the solution needed to become ASC 606 compliant. Click here to contact us or call 513-241-8313 for assistance with ASC 606 adoption today.