Financial | Nonprofit
March 10, 2021|
Revenue recognition standards change over time, and the unique nature of nonprofits requires special attention to rules that are continually evolving according to the changing business landscape.
When it comes to revenue recognition standards, nonprofit organizations are primarily concerned with two standards: one that covers contributions and another covering exchange transactions.
Recent changes by the Financial Accounting Standards Board (FASB) have now provided a new framework for revenue recognition that affects how these transactions are recorded and revenue is recognized. This easy guide will help familiarize you with those changes to make the necessary adjustments needed and prevent any unwelcome surprises in the event of an audit.
The typical way most nonprofit organizations recognize revenue is to:
One issue with that method is that creating an invoice does not necessarily mean that the revenue is recognized correctly. An invoice is simply a request to get paid, and while creating an invoice can result in the proper recognition of income, there are times when it goes nowhere because it doesn’t get paid.
That’s why some accountants prefer to record all income as cash when it is received, however, this is inconsistent with different types of transactions received by nonprofits. Understanding new rules is one of the barriers that must be overcome in order to clean up the books and produce accurate financial statements ahead of a potential audit.
Contributions include all donations, gifts, and grants. To qualify, they must be nonreciprocal, whereby the donor does not receive anything of value. Contributions must also be wholly voluntary and unconditional - unless it’s a matching grant. In that case, the income is recognized once the matching funds are raised.
Exchange transactions occur when each party voluntarily gives and receives something of approximately equal value. An example that can apply to a nonprofit would be a price-discounted meal in exchange for a reduced price for individuals with a relatively low income. Even if the nonprofit receives a below-market price for the service, it is still considered revenue and is recorded as an exchange transaction.
Transactions falling into a grey area between exchange transactions and contributions are called combo transactions. An example would be a special event or raffle where part of the ticket’s cost pays for the good or service, and part is a contribution to the organization. The way revenue is recognized in this case is to assign part of the ticket as a contribution and the other part as an exchange transaction.
An agency transaction is when the nonprofit receives funds restricted by a donor for a specific beneficiary. An example could be a fundraising drive that collects medical expense money for an individual undergoing treatment.
According to Generally Accepted Accounting Principles (GAAP), receiving cash may not necessarily imply that income was received. Applying the rules correctly in that case may then result in a significant change in financial statements that may pose huge problems during an audit.
This is especially true for exchange transactions. Nonprofits faced some challenges regarding exchange transactions after FASB released the Accounting Standards Update (ASU) 2014-09 in 2014. Accountants at different organizations interpreted the rules in different ways, resulting in inconsistent reporting across organizations.
FASB released ASU 2018-08, which provided a new framework that allowed accountants to clearly determine whether a transaction should be accounted for as a contribution or exchange transaction. ASU 2018-08 also provided criteria for determining if a contribution was conditional with implications on the transaction’s timing and when it could be recognized as revenue.
Finding out how to correctly record and recognize revenue depends on new rules laid out by the FASB in the following ASUs:
These updates have profound implications for nonprofit revenue recognition and are effective for the 2019 fiscal year and all calendar year audits moving forward.
Nonprofit revenue according to the new rules can be recognized and recorded using the following steps:
The first step is to determine if the money coming into the organization is an agency transaction. If so, record the funds as a liability on the balance sheet until they are paid out.
If the transaction is not an agency transaction, proceed with Step 2.
If the transaction is not an agency transaction, then use the following set of questions to determine if it is a contribution or exchange transaction:
If fees were charged for the organization’s service, then the revenue is considered an exchange. This includes contracts for deliverables or other specific services.
Fees charged for memberships that include benefits such as publications, special events, or education are classified as exchange transactions. If membership dues are partly a contribution, then they can be divided between both types of transactions.
Government grants are classified as contributions if they are charitable with benefits to the general public. Examples include grants that provide goods and services to children or senior citizens. Payments from government agencies, however, are classified as exchange transactions when connected to specific services such as Pell grants or Medicaid services tied to specific people.
Government grants are classified as contributions if they are charitable with benefits to the general public.
Government grants or programs that result in work where ownership rights go to the government are exchange transactions. Conversely, if funding for a program, such as university research, allows the school to retain ownership rights, the grant can be recorded as a contribution.
The American Institute of Certified Public Accountants (AICPA) provides the following chart that summarizes attributes that differentiate contributions and exchange transactions:
Not-for-profit (NFP) states that it is soliciting a contribution
NFP asserts that it is seeking resources in exchange for specified benefits
Resource provider asserts that it is making a contribution to support the NFP’s programs
Resource provider asserts that it is transferring resources in exchange for specified benefits.
Delivery method is at the discretion of the NFP
Delivery method is specified by the resource provider
Resource provider determines the amount of the payment
Payment by the resource provider equals the value of the assets to be provided by the recipient NFP of the asset's costs plus markup
NFP is not penalized for nonperformance
NFP is penalized for nonperformance
Assets are to be delivered to individuals or organizations other than the resource provider
Assets are to be delivered to the resource provider or to individuals and organizations closely connected to the resource provider
If the transaction is a contribution, the following steps can be taken:
There are many aspects to accounting for restricted gifts that go beyond the scope of this article. More information can be found on the website of The National Council for Nonprofits.
If the transaction is not a contribution, it falls under exchange revenue. Common sources of exchange revenue according to FASB include:
Rental income, leases, insurance reimbursements, guarantees, and nonmonetary exchanges are NOT included.
Exchange transactions are subject to the following steps:
Revenue recognition for nonprofits is now subjected to new standards through updates by FASB that include ASU 2014-09 - Revenue from Contracts with Customers, and ASU 2018-08 - Clarifying the Scope and the Accounting Guidance for Contributions Received and Contributions Made.
Nonprofits now have a comprehensive framework moving forward that gives clear guidance for recording contributions and revenue. Besides taking the stress out of a potential audit, these new procedures can help managers better understand nonprofit businesses along with how tax authorities assess the activities of the organization.
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