The Nonprofit’s Guide to Revenue Recognition
For nonprofits dealing with multiple revenue streams, understanding how and when to recognize different kinds of revenue is key to avoiding major missteps.
Digital Exclusive - 2020
The accounting and finance function encounters challenges in every industry, and nonprofit organizations are no different. Nonprofits often struggle to properly account for many different revenue streams, including donations, gifts and grants, membership dues, conference or educational course revenue, publishing revenue, advertising, and more. Although standards have continued to be adopted to provide clarity and consistency in the way nonprofits recognize revenue, there is still a substantial amount of ambiguity and complexity in the regulations that requires judgment. In fact, while applying some of the common accounting treatments for these revenue streams may initially make sense under generally accepted accounting principles, they could result in regulatory issues. Let’s take a closer look at the common revenue streams that nonprofits take in and their need-to-know general rules.
While nonprofits see a wide variety of revenue streams, revenue can be divided into two categories: nonreciprocal transactions (or contributions) and reciprocal transactions (or exchanges). Nonreciprocal transactions, like contributions or donations, require a different accounting treatment than reciprocal transactions, where each party gives and receives something of value, like a fee for membership.
Contributions are subject to the Financial Accounting Standards Board’s Accounting Standards Codification Topic 958, “Not-for-Profit Entities
,” and Accounting Standards Update 2018-08, “Clarifying the Scope and Accounting Guidance for Contributions Received and Contributions Made
,” under which unconditional contributions, including promises to give, are to be recorded as revenue in the period received at fair value. This guidance takes a cash basis approach to recording revenue, as it does not follow traditional accrual accounting rules.
Take the example of a nonprofit that receives a large contribution during the last month of their fiscal year with the explicit purpose to fund expenses to be incurred in the next fiscal year. Many nonprofits will have the urge to follow typical accrual accounting and defer the revenue until the next year when the expenses will be incurred, allowing them to match the revenue with the expenses. On the surface, this logic makes sense, as it would seem that in the year of receipt that the net income is overstated and the subsequent year it is understated. However, the full contribution should be recognized as revenue in the year of receipt, regardless of when the expenses are incurred. This would also be the case if the contribution were simply a promise to give, and some or all of the cash payments were to be received in subsequent years.
Reciprocal transactions (exchanges) are subject to Accounting Standards Update 2014-09, “Revenue From Contracts With Customers (Topic 606)
”, and the amount of revenue recorded reflects the consideration to which the nonprofit is entitled in exchange for goods or services. Revenue is generally recorded upon completion of the performance obligation of the organization.
For instance, membership dues revenue is recognized evenly over the period of the membership, as the nonprofit organization satisfies its performance obligation and members receive and consume membership benefits over that time frame. In contrast, program services revenue, including conference and educational course revenue, professional publications, and other services, is recognized at the point in time that events take place, goods are shipped, or services are rendered.
Contribution or Exchange?
While most transactions might be easily slotted into one of these two categories, it is not always easy to tell the difference between a reciprocal or nonreciprocal transaction. The difficulty often arises over whether the donor or provider receives commensurate value from the nonprofit. In these cases, the nonprofit needs to consider the terms of any contracts and the intent of the donor or provider in the determination. For instance, did the donor have full discretion over the amount given? That indicates a contribution, and thus a nonreciprocal transaction. Did the nonprofit and the donor work together to determine the amount transferred in exchange for goods and services? That indicates an exchange, or reciprocal, transaction.
Prior to the implementation of ASC 958, inconsistencies in how organizations accounted for grants from government or regulatory agencies were prevalent. Many thought the grants should be exchange transactions, with the donor agency receiving a commensurate benefit in the nonprofit carrying out the agency’s mission. In many of these cases, the nonprofit accounted for the grants as exchange transactions, recognizing the revenue as related expenses were incurred. ASC 958 provided clarification that commensurate value does not exist in such a transaction if the general public is the primary beneficiary of the goods or services, making grants nonreciprocal transactions.
Further complicating the accounting for contributions are conditional contributions or grants. A conditional contribution is not simply a restriction on how to spend the funds. Conditional contributions, including conditional promises to give, include a donor-imposed requirement that specifies a future and uncertain event that has to occur in order for the nonprofit to retain or receive the transferred assets. Conditional contributions are recognized as revenue when the conditions on which they depend are substantially met.
ASC 958 specifies that an organization should “determine whether a contribution is conditional on the basis of whether the agreement includes a barrier that must be overcome and either a right of return of assets transferred or a right of release of a promisor’s obligation to transfer assets.” A key indicator as to whether a barrier exists is the inclusion of a measurable performance-related condition in the agreement. Examples of measurable performance-related barriers include the occurrence of a specific outcome or event or achieving a certain level of service or output of goods. Another key indicator of a barrier is limited discretion on behalf of the nonprofit over the manner in which an activity is conducted. Once a barrier is met or explicitly waived by the donor, the contribution or grant becomes, in essence, unconditional, and the revenue is recognized in the period the conditions are met.
Similar to distinguishing between contributions and exchange transactions, determining if contribution or grant agreements are conditional can also be a challenge. Many grants contain stipulations on spending funds that are unclear as to whether the right to receive assets depends on the stipulations. Nonprofits should reach out to donors to provide clarity in many cases, but when donor stipulations and restrictions are unclear, they should be presumed to be conditional.
Financial standards will continue to change, hopefully becoming clearer and more consistent over time, but as long as room for judgment remains, nonprofits can follow these principles to stay on course.
Illinois CPA Society member Chad Porter, CPA, is a partner with Kutchins, Robbins & Diamond Ltd. and heads their non-profit practice. He has worked in public accounting for more than 30 years, and his expertise is in providing audit and consulting services to clients in the nonprofit, real estate, construction, and manufacturing industries.