Accounting Standards Update (ASU) 2018-08, titled Clarifying the Scope and the Accounting Guidance for Contributions Received and Contributions Made, was released by the Financial Accounting Standards Board (FASB) on June 21. It clears up some of the more ambiguous facets of the new revenue recognition model that will go into effect for most nonprofits at the end of this year. Accounting Standards Codification (ASC) 606, commonly referred to as “the new revenue recognition standard,” instructs entities to recognize contract revenue using a five-step model. Nonprofits discovered that it was difficult to apply this five-step model to some of their common revenue streams, and the FASB took their concerns into consideration by releasing ASU 2018-08 for guidance.
Why Is the New Revenue Recognition Standard Confusing to Nonprofits?
ASC 606 attempts to streamline the process for recognizing revenue resulting from contracts with customers. It requires entities to apply a five-step model before revenue can be recognized. You can read more about that here.
Nonprofits view this five-step model quite differently than for-profit entities do. The very first step — identifying when a contract exists — is particularly problematic. Some revenue very clearly is generated from contracts with customers — for example, a fee to adopt an animal, college tuition, or hospital charges. Other revenue streams, however, are not as clear-cut. Among these more ambiguous revenue streams are contributions and grants.
Are Contributions and Grants Considered Contract Revenue?
To begin unwrapping this question, we must determine if the contribution or grant is considered an exchange transaction, a partial exchange transaction, a third-party payer transaction, or a true contribution.
Exchange Transaction (Reciprocal)
An exchange transaction is when both parties receive something of commensurate value. Consider tuition. The customer is receiving something (education) of a value commensurate with their payment (tuition). Reciprocal exchange transactions are considered contracts and would be accounted for under the five-step model of ASC 606.
Exchange Transaction (Partial)
A partial exchange transaction is when both parties receive something of value in the transaction, but the values are imbalanced. When a donor buys a $100 ticket to your organization’s fundraising event, which features a dinner valued at $40, we have a partial exchange transaction. The donor is receiving something of value (dinner), but the value is not equal to their donation. In this instance, $40 would be considered an exchange transaction, and the remaining $60 would be considered a contribution. The reciprocal portion of the transaction would be accounted for under the five-step model of ASC 606. The nonreciprocal portion of the transaction would be accounted for under the new ASU 2018-08.
Third-Party Payer Transaction
A third-party payer transaction is when an outside party, often the government, supplies the nonprofit with funding to support an existing contract with an identified customer. The simplest example of this type of transaction is Medicare. The state or federal government provides third-party funding to the nonprofit, which then uses that money to provide services to Medicare recipients. Third-party payer transactions do not fall under the guidance of either ASC 606 or ASU 2018-08.
Nonreciprocal transactions exist when value is donated, like when a patron writes a $100 check at a fundraising event without receiving anything in return. Nonreciprocal transactions are accounted for under the new ASU 2018-08.
Grants from government entities and private foundations might be exchange transactions if the funder receives something of value — for example, if the grant stipulates that the funding agency retains all rights to the funded research. As long as the benefits flow to the general public and not directly to the funding entity, however, the grant will likely be considered a contribution.
These distinctions require careful judgment and interpretation, so be sure to consult experienced nonprofit accountants to help you select the accounting guidance most appropriate for each particular transaction. The following flowchart can help guide the discussion.
Is the Contribution or Grant Conditional?
Nonreciprocal contributions can be either conditional or unconditional, and their revenues will be recognized differently. A conditional contribution or grant is one that has (1) a barrier to overcome before the nonprofit can use the funds, and (2) an agreement that includes a right of return of assets, or a right to release the donor from his or her obligation to transfer the funds. If you’re unsure, then simply ask the funder their intent. Did they intend to provide funding on a conditional basis? Asking this question up front can help clear up ambiguities.
An example of a conditional donation is when an individual pledges to donate $20,000 only if the nonprofit is able to raise funds above a certain threshold. If the nonprofit receives the funds before the conditions are met (perhaps because the conditions will be met imminently, so the individual chooses to fulfill their pledge at once), then the nonprofit should record the donation on the statement of financial position as a liability, and should release that liability when (or as) the conditions are met. If the money is simply pledged but not yet given, then nothing is recorded.
Is the Contribution or Grant Restricted?
Once a contribution is deemed unconditional, whether the contribution was initially free from barriers or the conditional barriers have been met, the nonprofit should record an asset, because they have a right to those funds. However, the contribution may be recorded in one of two ways: as an asset with or without donor restrictions. ASU 2018-08 continues to allow the “simultaneous release option” on donor-imposed restricted donations. This option allows the nonprofit to record an asset without donor restriction for the donation as long as the restriction is met (and therefore the revenue is recognized) within the same reporting period. This method simplifies the reporting process.
The contribution guidance provided by ASU 2018-08 can be viewed in the following flowchart. Nonprofits can ask themselves the following questions about each of their nonreciprocal (i.e., non-exchange) transactions:
Start Talking with Your CPA
ASC 606 threw all the prevailing revenue recognition strategies out the window and started fresh for all types of entities, but nonprofits were left with several significant questions. That’s why ASU 2018-08 has been so helpful. The flowcharts above are great conversation starters for you and your team. Going through the questions systematically will help you understand what types of transactions you have so you can determine how to record the resulting revenues. You can begin working with your team today to prepare for your first reporting period using these new standards at the start of your next fiscal year. And of course, ask a CRI advisor if you have any further questions.