The new revenue recognition standard effective in 2019 may impact your nonprofit greatly – or it may mean very little.
There have been some misconceptions about the new regulations, so here we will clarify how they will impact nonprofits.
The new standard deals with contracts with customers so its impact depends entirely on the nature of your revenue and support…
Does your nonprofit have “contracts with customers”?
A nonprofit’s revenue and support generally falls into two categories:
- Contributed/charitable/philanthropic support (e.g. foundation grants, individual donations, etc.)
- Earned income (e.g. program service fees, certain membership dues, etc.)
Some nonprofits assign these two buckets the names “contributions” and “exchange transactions”.
The new standard (ASU 2014-09) only applies to earned income/exchange transactions and will be effective for years beginning after December 15, 2018, for most nonprofits.
If your nonprofit relies entirely on contributions, you don’t have “contracts with customers” and therefore the new regulations will not affect you.
What do the new regulations mean for earned income?
So what does the new revenue recognition standard require you do with your earned income/exchange transactions?
The FASB has laid out a five-step methodology for recognizing such revenue from “contracts with customers”.
- Identify the contract
- Identify the contract’s performance obligations
- Determine the transaction price
- Allocate the transaction price to the various performance obligations
- Recognize the revenue when/as you satisfy the respective performance obligations
Even if you have a substantial amount of earned income, there may not be much of an effect on your organization’s day-to-day accounting if your program revenue is driven by small transactions resulting from short-term events.
Example 1:
You are a nonprofit theater company and you sell tickets to performances.
Before the new standard, you recognized the revenue from ticket sales when the performances occurred.
Under the new revenue recognition standard, you will still recognize the revenue when the performances occur.
Example 2:
Your theater company has contracts with local school districts to provide various services, such as developing curricula, holding after-school programs, and assisting with the professional development of teachers.
Your fiscal year is the calendar year, while the contracts with the districts coincide with the school year.
Under these circumstances, the 5-step revenue recognition process would need to be followed and the timing of when you recognize revenue in your financial statement may differ from years past.
How does the new standard affect government grants & contracts?
If you receive funding from government agencies, how is it affected by the new revenue recognition standard?
Such income is often considered to be earned income (even when it is not), based on the notion that the government “subcontracts” or “outsources” certain responsibilities to nonprofits.
Many nonprofit accountants believe this is why government funding is commonly recognized as revenue in monthly installments as “services are performed” instead of recognizing it in the financials all at once when the award is made (as you would typically do with a contribution).
To clear up some misconceptions that exist in this area, FASB issued proposed guidance in August 2017 that will likely have the same effective date the new revenue recognition standard.
Following are a few of the key takeaways from this guidance:
- Government agencies enter into exchange transactions with nonprofits AND make contributions to nonprofits. Nonprofits will need to apply professional expertise when determining whether payments received are exchange transactions or contributions.
- To be classified as an exchange transaction, the resource provider (e.g. government agency) receives a benefit that is commensurate with the resources provided. A commensurate benefit would not include the fact that the nonprofit is serving the constituents of the government agency or the notion that a nonprofit is doing the work that the government would otherwise be responsible for. The benefits received by the public do not count as benefits received by the resource provider.
- Government funding deemed an exchange transaction in the past may actually be a conditional contribution (not to be confused with a contribution that is merely donor-restricted). Because conditional contributions have significant “hurdles” to overcome in order to receive funding, revenue is only recognized to the extent that the hurdles have been satisfied. With government awards that are conditional, this revenue recognition commonly occurs monthly as nonprofits report back to funders and request payment for the milestones that have been accomplished. Under the new guidance, a greater number of government funding streams will likely be classified as conditional contributions rather than exchange transactions. Despite the change in classification, how and when you report the government revenue (i.e. in installments as milestones are accomplished) may end up being the same. (And remember, if your accountants and auditors conclude that your government funding represents a conditional contribution, you will not need to apply the 5-step methodology discussed earlier. Yay!)
FASB has provided a summary of the proposed guidance, as well as a flowchart to assist in distinguishing exchange transactions from contributions, conditional from unconditional contributions, and contributions with donor restrictions from contributions without donor restrictions.
For further reading, consider the new standard on recognizing revenue on contracts with customers, as well as FASB’s exposure draft of the proposed guidance relating to contributions.
