Have you ever wondered if the way an agreement is titled would make a difference in when or how to recognize revenue? Not-for-profit (NFP) entities frequently have multiple types of revenue ranging from grant awards, contributions, contracts, sponsorships, cooperative agreements, fees, etc. Often times, a written agreement may even have multiple revenue components included in one contract. The term used in the presentation of financial statements to label revenue is no longer a factor in determining whether an agreement is now within the scope of the new guidance just issued.
On June 21, 2018, the FASB issued Accounting Standards Update 2018-08, Clarifying the Scope and the Accounting Guidance for Contributions Received and Contributions Made (ASU 2018-08). This new standard applies to all NFP entities that receive or make contributions.
Prior to the issuance of ASU 2018-08, NFPs recognized revenue based on distinguishing their nonreciprocal transactions (contributions) from reciprocal transactions (exchanges) and whether the contribution was unconditional or conditional. The new ASU 2018-08 is designed to address both the difficulty and diversity in practice among NFPs in characterizing grants and contracts with governmental agencies and others and when to recognize grants made. ASU 2018-08 also provides illustrative examples. The accompanying decision tree flowchart on accounting for grants is a helpful resource as management makes its decisions on when to recognize revenue.
ACCOUNTING FOR GRANTS DECISION TREE
WHERE TO START ON DOCUMENTING REVENUE RECOGNITION
The best place to start after understanding the changes required is to inventory all of the revenue streams that a NFP has in order to determine which accounting model to follow: either it’s a contribution or the rules of ASU 606 are applicable for an exchange transaction.
For revenue using contribution accounting, an NFP needs to further determine if any changes are needed for accounting recognition to determine the conditional or unconditional criteria. The next step would be to document the decisions reached for each of the individual revenue streams and/or individual agreements based on the new guidance and determine that the NFP can capture all of information required for disclosures.
NFPs which have grant expenditures would also perform similar procedures to identify all contributions made and promises to give grants and awards. The final step would be for management to decide on the application of either a modified prospective transition approach or a retrospective application transition approach.
KEY CLARIFICATIONS ADDRESSED IN ASU 2018-08
Reciprocal vs. Nonreciprocal
An exchange transaction is a reciprocal transfer agreement in which each party receives and sacrifices approximately commensurate value, such as purchasing goods and services. Revenue recognition would be recognized following the standards applicable under ASU 606, Revenue from Contracts with Customers. The core principle of this topic is that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be exchanged for those goods or services. An entity typically allocates the transaction price to each performance obligation on the basis of the relative standalone selling prices of each distinct good or service promised in the contract. Thus, a grant agreement with multiple components may need to be disaggregated for different revenue types to determine when to recognize revenue.
If a grantor or resource provider receives value indirectly by the NFP providing a benefit to the general public or society as a whole from the program specified in the agreement, then the transaction would be classified as a nonreciprocal and guidance for contributions would be followed. If a third party is a primary beneficiary of an agreement, then the NFP must use judgment to determine if the transaction is reciprocal or nonreciprocal. The type of resource provider should not override the substance of the transaction, i.e. whether the resource provider is a governmental agency or private foundation.
Conditional vs. Unconditional
Unconditional grants are recognized immediately as revenue. Under the new standards, in order for the grant to be considered conditional, the agreement must include both a barrier and a disclosure exists in the grant agreement whereby the resource provider has a right of return for transferred assets or a right of release from obligations if conditions are not met. Note: conditional grants and conditional promises-to-give should be disclosed in the footnotes to the financial statements – this applies to both recipient and resource providers.
If an agreement is determined to be conditional, then revenue is recognized only when the condition(s) are met. Barriers may exist if there’s a measurable performance requirement; a condition limits the NFP’s discretion on how to conduct an activity; or the condition is directly related to the purpose of the agreement. If the grant agreement requires a report on the grant expenditures or requires an annual audit, these administrative requirements alone are not considered a barrier. In addition, including a general budget in a grant proposal is also not considered a barrier to entitlement because adherence to the budget still allows the NFP to have a broad discretion on expenses.
It may be necessary for NFPs to obtain further clarification directly from the resource provider regarding whether a right of return/right of release is required if the grant agreement is silent on this issue.
GRANTS OR CONTRIBUTIONS MADE BY THE RESOURCE PROVIDER
In determining whether a gift or grant made to others is conditional or unconditional, the donor will use the same criteria as specified above for the recipient (i.e., a barrier exists along with the right of return/right of release statement). Expense recognition would be deferred if a conditional agreement exists while expense recognition and/or obligation would be recorded immediately if the grant or gift is unconditional.
Under the modified prospective transition method, a NFP will apply the new accounting standards to all new agreements entered into after the effective date as well applying the new standards to the remaining portions for any prior year agreements that have not been completed. No restatements of prior amounts recognized will be required. As an alternative, a NFP may elect full retrospective application.
WHEN TO IMPLEMENT
The changes affecting revenue recognition for resource recipients will take effect for annual periods after December 15, 2018 (i.e., calendar year 2019) and interim periods beginning after December 15, 2019, except for NFP conduit bond obligors will implement starting July 1, 2018.
The provisions for contributions made and expensed by resource providers are effective one year later (i.e., calendar year 2020). Early adoption is permitted for all entities.
In closing, the transition to the new standards will be complicated and implementation will require significant time, effort, and documentation. UHY LLP’s team of NFP professionals can work with your management team now to provide assistance in analyzing the components of grants and contracts to help avoid any year-end adjustments.