Ready or not, revenue recognition is changing. Two major new accounting standards — Accounting Standards Codification 606, Revenue from Contracts with Customers (Topic 606) and Accounting Standards Update 2018-08, Clarifying the Scope and the Accounting Guidance for Contributions Received and Contributions Made (ASU 2018-08) — are now effective.
That means nonprofits are running out of time to implement required changes to the revenue recognition and financial reporting process. To help jump-start your implementation, we have provided the following project blueprint.
Phase 1: Assemble a team.
In addition to a member of the finance and accounting team, you’ll likely want someone from development/fundraising, marketing, HR, IT, and perhaps program services. While they need not be experts on accounting rules, they should be knowledgeable about the ways their systems and processes are linked to revenue recognition. The project lead will oversee the development of the implementation plan and should be fully up to speed on the standards and all related guidance.
Phase 2: Inventory revenue streams.
The team will need to inventory all revenue streams and analyze each one to determine whether it is within scope for ASC 606, ASU 2018-08, both, or neither.
To facilitate the revenue recognition decision process, consider the following key questions:
Does each party in the transaction receive something of value? If so, then it is an exchange transaction and should be accounted for under the five-step model of ASC 606. However, if the donor does not receive anything of value, or the value is not commensurate to the amount of consideration, then proceed to the next question.
Is the payment from a third-party payer that is part of an existing exchange transaction? If so, then account for it as you have in the past. If not, then it is a nonreciprocal transaction, and you have just one more question to answer…
Does the transaction include a barrier (i.e., right of return and right of release)? If so, then recognize revenue as conditions are met. If not, then recognize the revenue immediately, taking into account whether or not the contribution is donor restricted.
Phase 3: Remediate gaps.
Once Phase 2 is complete, your team will likely have identifies a number of gaps that will need to be remediated. For example:
- Revenue recognition policies and revenue footnote disclosures will likely require significant changes to satisfy the new rules.
- Accounting processes, internal controls, and associated documentation may need to be updated.
- IT systems may require additional capabilities and capacity for data collection and reporting.
- Legal language in contracts may need to be revised. Debt covenants in agreements with financial institutions or other lenders may also be impacted.
Phase 4: Monitor and evaluate.
Think of the monitoring process as a check for effectiveness and continuous improvement — similar to a home inspection, which might identify opportunities to make a quick fix or to invest in home renovations.
A monitoring plan should address the following questions:
- Are the implemented changes effectively placing the organization in compliance with the new revenue recognition standard while also supporting strategic and operational goals?
- How often will contracts and IT systems be reviewed for relevance, accuracy, and compliance?
- Are the internal controls that were updated as part of the implementation process still operating effectively to prevent and detect material misstatements?
- What is the timeline for generating and distributing monitoring reports to stakeholders?
When you are ready for a deeper dive into these new standards, read our article on how nonprofits should account for contributions, and then listen to our not-for-profit revenue recognition webinar.