New Revenue Recognition Standards
The landscape surrounding revenue recognition is changing dramatically in 2019, and nonprofit organizations are not exempt from its effects. In fact, the way you record revenue for certain types of transactions could be changing.
Two new revenue recognition standards are effective for years ending December 31, 2019. One relates specifically to contributions and grants (which affects most nonprofits), and one covers most other revenue sources (which will have minimal effect for most nonprofits). Both standards are intended to reduce diversity in practice and ensure all organizations are recording revenue in the same manner. Some of the key issues included in these standards include:
Currently, membership dues are recorded over the term of the membership period, regardless of what benefits the member is receiving. Under the new guidance, you will need to document exactly what the member is paying for and analyze each of those components to determine how revenue should be recognized. For example, if a member pays $100 for annual dues, receives quarterly newsletters, and has access to your facility and website (which is not available to nonmembers), each of those items is considered to be a performance obligation for which a portion of the $100 in dues must be allocated. The timing of recording that revenue may also change – for example, the portion of revenue related to the newsletters would be recognized at the time the newsletter is delivered to the member, while the portion related to facility access would be recognized over the term of the membership.
Nonrefundable Upfront Fees
Many nonprofits charge an application fee to cover the cost of processing applications for reduced rate services, low income housing, etc. These fees were generally recorded as revenue at the time of receipt due to the fact they were nonrefundable. Under the new guidance, nonprofits must determine if the customer is receiving something in return for the application fee. If the fee is merely to cover costs of processing by the nonprofit, the customer receives nothing in return, and no performance obligation exists. Therefore, the fee should be recognized over the term of the service that will be performed (e.g. over the term of the low-income housing lease).
Splitting Transactions Between Contribution and Exchange Transactions
Although the accounting rules have always required consideration of what a donor receives in return for their contribution, this analysis becomes more critical with the change in revenue rules. For example, if the nonprofit charges $500 per ticket for a fundraising dinner, the portion of the ticket representing the cost of the meal provided is an exchange transaction. The remaining portion of the ticket price is a contribution. The two different pieces of the transaction follow different revenue recognition rules, and must be considered appropriately under those rules.
Significant diversity in practice exists in accounting for grants, resulting in the potential for nonprofits to account for the same exact grant in a different manner based on how the accounting rules are interpreted. New guidance is meant to eliminate these discrepancies and provide for more consistency in accounting. Under this guidance, a clearer definition of when a grant is considered a contribution exists. If the granting agency does not receive commensurate value in return for the grant given to the nonprofit, the grant is considered to be a contribution. The next step in the process would be to determine if the grant is conditional or unconditional (see below). Unconditional grants are recorded with or without donor restriction, with any restrictions being released upon satisfying the donor’s wishes. The new accounting guidance specifically states that the granting agency is not synonymous with the general public – if the only benefit received by the granting agency is societal benefit (e.g. housing the homeless), commensurate value is not exchanged, and the grant is deemed to be a contribution. In many cases, nonprofits have been calling these grants exchange transactions, so significant changes in timing of recognition could occur.
Another area of diversity in the nonprofit accounting world relates to whether contributions are unconditional (and can be recorded immediately) or conditional (and can’t be recorded until conditions are met). For a grant to be considered conditional, it must include a barrier to overcome and either the right of return of assets transferred or the right of release of the promisor’s obligation to transfer the assets. Barriers may be measureable performance-related barriers (e.g. achieving a certain level of service or obtaining a certain level of matching dollars before the contribution is given) or may stipulate limits on how activities are conducted (e.g. approval of expenses before they are allowed to be reimbursed or the hiring of a specific position). Administrative or trivial items, such as filing of an annual report, are not considered to be barriers that would result in a contribution being conditional.
The two new revenue standards are complex and require a significant amount of analysis and judgment. The above examples are not all-inclusive and do not contain all the specific details that need reviewed in order to determine the timing and amount of revenue your organization will recognize. You will need to review the standards closely and document your revenue streams in order to ensure compliance. This will be a significant component of your audit beginning with the December 31, 2019 financial statements. Contact the experts at Ketel Thorstenson, LLP today for assistance!